Stellar Bancorp, Inc. - Annual Report: 2021 (Form 10-K)

Table

​

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

​

FORM 10-K

​

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

​

For the fiscal year ended December 31, 2021

or

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

For the transition period from ____   to   ____.

Commission File Number: 001-38280

CBTX, Inc.

(Exact name of registrant as specified in its charter)

9 Greenway Plaza, Suite 110

Houston, Texas 77046

(Address of principal executive offices)

​

(713) 210-7600

(Registrant’s telephone number, including area code)

​

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

​

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

​

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

​

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.

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 has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐

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

​

As of June 30, 2021, the aggregate market value of the registrant’s common stock held by non-affiliates was approximately $496.3 million.

​

As of February 18, 2022, there were 24,608,462 shares of the registrant’s common stock, par value $0.01 per share outstanding, including 106,442 shares of unvested restricted stock deemed to have beneficial ownership.

​

​

​

Table

CBTX, INC.

​

​

​

Table

PART I.

Item 1. Business

The disclosures set forth in this item are qualified by “Item 1A.—Risk Factors” and the section captioned “Cautionary Note Regarding Forward-Looking Statements” in “Part II.—Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other cautionary statements set forth elsewhere in this Annual Report on Form 10-K.

All references to “we,” “our,” “us,” “ourselves,” and “the Company” refer to CBTX, Inc. and its consolidated subsidiaries and all references to “CommunityBank of Texas” or “the Bank” refer to CommunityBank of Texas, National Association, its wholly-owned bank subsidiary, unless otherwise indicated or the context otherwise requires. All references to “Houston” refer to the Houston-The Woodlands-Sugar Land Metropolitan Statistical Area, or MSA, and surrounding counties, references to “Beaumont” refer to the Beaumont-Port Arthur MSA and surrounding counties and references to “Dallas” refer to the Dallas-Fort Worth-Arlington MSA and surrounding counties.

CBTX, Inc. is a Texas corporation and bank holding company incorporated in 2007 that offers banking services through its wholly owned subsidiary, CommunityBank of Texas. The Bank’s headquarters are located at 5999 Delaware Street, Beaumont, Texas 77706 and the telephone number is (409) 861-7200. A majority of the Company’s executives are located in the Company’s Houston office at 9 Greenway Plaza, Suite 110, Houston, Texas 77046 and the telephone number is (713) 210-7600. The Company completed an initial public offering of its common stock on November 10, 2017. The Company’s common stock is listed on the Nasdaq Global Select Market, or Nasdaq, under the symbol “CBTX.”  

The Bank operates 18 branches located in the Houston market, 15 branches located in the Beaumont market and one branch in the Dallas market. The Company has experienced significant organic growth since commencing banking operations, as well as growth through mergers, acquisitions and opening new, or de novo, branches. The Company is focused on controlled profitable growth. Total assets increased from $2.6 billion at December 31, 2014 to $4.5 billion as of December 31, 2021. The loan portfolio at December 31, 2021 was 77.7% in the Houston market and 20.0% in the Beaumont market. The Company believes that there are significant ongoing growth opportunities in its markets.

The Bank is primarily a business bank with a focus on providing commercial banking solutions to small and medium-sized businesses and professionals including attorneys, accountants and other professional service providers with operations in its markets. The Bank offers a broad range of banking products, including commercial and industrial loans, commercial real estate loans, construction and development loans, 1-4 family residential mortgage loans, multi-family residential loans, consumer loans, agricultural loans, treasury services, traditional retail deposits and a full suite of online banking services. The Bank has a relationship-based approach, and at December 31, 2021, 79.9% of the Bank’s loan customers also had a deposit relationship with the Bank.

The banking and financial services industry is highly competitive, and the Company competes with a wide range of financial institutions within its markets, including local, regional and national commercial banks and credit unions. The Company also competes with mortgage companies, brokerage firms, consumer finance companies, mutual funds, securities firms, insurance companies, third-party payment processors, financial technology companies and other financial intermediaries for certain of the Company’s products and services. Some of the Company’s competitors are not subject to the same regulatory restrictions and the level of regulatory supervision applicable to the Company.

Interest rates on loans and deposits, as well as prices on fee-based services, are typically significant competitive factors within the banking and financial services industry. Many of the Company’s competitors are much larger financial institutions that have greater financial resources and compete aggressively for market share. These competitors attempt to gain market share through their financial product mix, pricing strategies and banking center locations. Other important competitive factors in the Company’s industry and markets include office locations and hours, quality of customer service, community reputation, continuity of personnel and services, technology resources capacity and willingness to extend credit and ability to offer sophisticated banking products and services.

The Bank seeks to remain competitive with respect to fees charged, interest rates and pricing and the Bank believes that its broad and sophisticated suite of financial solutions, high-quality customer service culture, positive reputation and long-standing community relationships enable it to compete successfully within its markets and enhances its ability to attract and retain customers.

Table

Pending Merger

​

On November 8, 2021, Allegiance Bancshares, Inc., or Allegiance, the holding company of Allegiance Bank, and the Company jointly announced that they entered into a definitive merger agreement pursuant to which the companies will combine in an all-stock merger of equal. Under the terms of the definitive merger agreement, Allegiance shareholders will receive 1.4184 shares of the Company’s common stock for each share of Allegiance common stock they own. Based on the number of outstanding shares of Allegiance and the Company as of November 5, 2021, Allegiance shareholders are expected to own approximately 54% and the Company’s shareholders will own approximately 46% of the combined company’s common stock. The companies have submitted the required regulatory filings and the parties anticipate closing the transaction in the second quarter of 2022.

​

Human Capital

The Company’s success depends on its ability to attract and retain highly qualified senior and middle management and other skilled employees. Competition for qualified employees can be intense and it may be difficult to locate personnel with the necessary combination of skills, attributes and business relationships.

​

The Company believes that its employees are the primary key to the Company’s success as a financial institution. The Company is committed to attracting, retaining and promoting top quality talent regardless of sex, sexual orientation, gender identity, race, color, national origin, age, religion and physical ability. The Company strives to identify and select the best candidates for all open positions based on qualifying factors for each job. The Company is dedicated to providing a workplace for its employees that is inclusive, supportive and free of any form of discrimination or harassment; rewarding and recognizing its employees based on their individual results and performance; and recognizing and respecting all of the characteristics and differences that make each of the Company’s employees unique.

​

Additionally, the Company is committed to employee development, including through a mentorship program, which provides retail staff with one-on-one training with experienced employees. Further, the Company has an officer development program with formal in-house training programs for junior bankers including guidance from senior banking team members.

​

As of December 31, 2021, the Company employed 506 full-time equivalent employees.

Available Information

The Company’s website address is www.communitybankoftx.com. The Company makes available free of charge on or through its website, under the investor relations tab, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, as soon as reasonably practicable after such materials are electronically filed with or furnished to the Securities and Exchange Commission, or SEC. Information contained on the Company’s website is not incorporated by reference into this Annual Report on Form 10-K and is not part of this or any other report that the Company files with or furnishes to the SEC. The SEC maintains an internet site that contains reports, proxy statements and other information that the Company files with or furnishes to the SEC and these reports may be accessed at http://www.sec.gov.

Supervision and Regulation

The United States, or U.S., banking industry is highly regulated under federal and state law. Consequently, the Company’s growth and earnings performance will be affected not only by management decisions and general, national and local economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. These authorities include the Board of Governors of the Federal Reserve System, or Federal Reserve, Office of the Comptroller of the Currency, or OCC, Federal Deposit Insurance Corporation, or FDIC, Consumer Financial Protection Bureau, or CFPB, Internal Revenue Service, or IRS, and state taxing authorities. The effect of the statutes, regulations and policies, and any changes to such statutes, regulations and policies, can be significant and cannot be predicted.

The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system, facilitate the conduct of sound monetary policy and promote fairness and transparency for financial products and services. The system

Table

of supervision and regulation applicable to the Company and its subsidiaries establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s Deposit Insurance Fund, the Bank’s depositors and the public, rather than the Company’s shareholders or creditors. The description below summarizes certain elements of the applicable bank regulatory framework. This description is not intended to describe all laws and regulations applicable to the Company and its subsidiaries, and the description is qualified in its entirety by reference to the full text of the statutes, regulations, policies, interpretive letters and other written guidance that are described herein.

Financial Services Industry Reform. The Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, mandates certain requirements on the financial services industry, including, among many other things: (i) enhanced resolution authority with respect to troubled and failing banks and their holding companies; (ii) increased regulatory examination fees; (iii) creation of the CFPB, an independent organization dedicated to promulgating and enforcing consumer protection laws applicable to all entities offering consumer financial products or services; and (iv) numerous other provisions designed to improve supervision and oversight, and strengthen safety and soundness, of the financial services sector. Additionally, the Dodd-Frank Act established a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve, the OCC and the FDIC.

On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act, or the Regulatory Relief Act, was enacted. The Regulatory Relief Act repealed or modified several provisions of the Dodd-Frank Act and included a number of burden reduction measures for community banks, including, among other things, directing the federal banking regulators to develop a community bank leverage ratio for banking organizations that have less than $10.0 billion in total assets and have certain risk profiles (discussed in “Part II.—Item 8.—Financial Statements and Supplementary Data—Note 19”), exempting certain banking organizations with less than $10.0 billion or less in total assets from the Volcker Rule (discussed below), narrowing and simplifying the definition of high volatility commercial real estate and requiring the federal banking regulators to raise the asset threshold under the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement from $1.0 billion to $3.0 billion.

The Regulatory Relief Act also expands the eligibility for certain small banks to undergo 18-month examination cycles, rather than annual cycles, raising the consolidated asset threshold from $1.0 billion to $3.0 billion for eligible banks. In addition, the Regulatory Relief Act added certain protections for consumers, including veterans and active duty military personnel and student borrowers, expanded credit freezes and created an identity theft protection database.

Regulatory Capital Rules. The Company and the Bank are each required to comply with applicable capital adequacy standards established by the Federal Reserve and the OCC. The current risk-based capital standards applicable to the Company and the Bank are based on the December 2010 final capital framework for strengthening international capital standards, known as Basel III, of the Basel Committee on Banking Supervision, or Basel Committee. In July 2013, the federal bank regulators approved final rules implementing the Basel III framework, or the Basel III Capital Rules, as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). The Basel III Capital Rules require banks and bank holding companies, including the Company and the Bank, to maintain four minimum capital standards: (i) a Tier 1 capital-to-adjusted total assets ratio, or leverage capital ratio, of at least 4.0%; (ii) a Tier 1 capital to risk-weighted assets ratio, or Tier 1 risk-based capital ratio, of at least 6.0%; (iii) a total risk-based capital (Tier 1 plus Tier 2) to risk-weighted assets ratio, or total risk-based capital ratio, of at least 8.0%; and (iv) a Common Equity Tier 1, or CET1, capital ratio of at least 4.5%.

The Basel III Capital Rules also require bank holding companies and banks to maintain a “capital conservation buffer” on top of the minimum risk-based capital ratios. The buffer is intended to help ensure that banking organizations conserve capital when it is most needed, allowing them to better weather periods of economic stress. The buffer, which became fully phased in on January 1, 2019, requires banking organizations to hold CET1 capital in excess of the minimum risk-based capital ratios by at least 2.5% to avoid limits on capital distributions and certain discretionary bonus payments to executive officers and similar employees.

​

The Basel III Capital Rules implemented changes to the definition of capital. Among the most important changes were stricter eligibility criteria for regulatory capital instruments that disallow the inclusion of certain instruments, such as trust preferred securities (other than grandfathered trust preferred securities), in Tier 1 capital, new constraints on the inclusion of minority interests, mortgage-servicing assets, deferred tax assets and certain investments in the capital of unconsolidated financial institutions, and the requirement that most regulatory capital deductions be made from CET1

Table

capital. The Basel III Capital Rules also changed the methods of calculating certain risk-weighted assets, which in turn affected the calculation of risk-based ratios. Under the Basel III Capital Rules, higher or more sensitive risk weights are assigned to various categories of assets, including certain credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or on nonaccrual status, foreign exposures and certain corporate exposures. In addition, these rules include greater recognition of collateral and guarantees, and revised capital treatment for derivatives and repo-style transactions.

​

The Basel III Capital Rules permit the Federal Reserve and the OCC to set higher capital requirements for individual institutions whose circumstances warrant it. For example, institutions experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. At this time, the bank regulatory agencies are more inclined to impose higher capital requirements to meet “well capitalized” standards and future regulatory change could impose higher capital standards as a routine matter. The Company’s regulatory capital ratios and those of the Bank are in excess of the levels established for “well capitalized” institutions under the rules.

​

The federal banking regulators have modified certain aspects of the Basel III Capital Rules since the rules were initially published, and additional modifications may be made in the future. In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (commonly referred to as Basel IV). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provides a new standardized approach for operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2023, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company or the Bank. The impact of Basel IV on the Company will depend on the manner in which it is implemented by the federal banking regulators.

​

Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators are required to take prompt corrective action to resolve problems associated with insured depository institutions whose capital declines below certain levels as further described below. In the event an institution becomes undercapitalized, it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company having control of the undercapitalized institution guarantees the subsidiary’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy.

The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5.0% of the institution’s assets at the time it became undercapitalized and the amount necessary to cause the institution to become adequately capitalized. The bank regulators have greater power in situations where an institution becomes significantly or critically undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve approval of proposed dividends or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.

Volcker Rule. As mandated by the Dodd-Frank Act, in December 2013, the OCC, Federal Reserve, FDIC, SEC and Commodity Futures Trading Commission issued a final rule implementing certain prohibitions and restrictions on the ability of a banking entity and nonbank financial company supervised by the Federal Reserve to engage in proprietary trading and have certain ownership interests in, or relationships with, a “covered fund”, or the Volcker Rule. The Regulatory Relief Act discussed above included a provision exempting banking entities with $10.0 billion or less in total consolidated assets, and total trading assets and trading liabilities that are 5.0% or less of total consolidated assets, from the Volcker Rule. Thus, the Company and the Bank are not currently subject to the Volcker Rule.

CBTX, Inc.

As a bank holding company, the Company is subject to regulation under the Bank Holding Company Act of 1956, as amended, or BHC Act, and to supervision, examination and enforcement by the Federal Reserve. The BHC Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations. The Federal Reserve’s jurisdiction also extends to any company that the Company directly or indirectly controls, such as any nonbank subsidiaries and other companies in which it owns a controlling investment.

Table

Acquisitions by Bank Holding Companies. The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before it acquires all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank or bank holding company if after such acquisition it would own or control, directly or indirectly, more than 5.0% of the voting shares of such bank or bank holding company. In approving bank holding company acquisitions by bank holding companies, the Federal Reserve is required to consider, among other things, the effect of the acquisition on competition, the financial condition, managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, including the record of performance under the Community Reinvestment Act of 1977, or CRA, the effectiveness of the applicant in combating money laundering activities and the extent to which the proposed acquisition would result in greater or more concentrated risks to the stability of the U.S. banking or financial system. The Company’s ability to make future acquisitions will depend on its ability to obtain approval for such acquisitions from the Federal Reserve. The Federal Reserve could deny the Company’s application based on the above criteria or other considerations. For example, the Company could be required to sell banking centers as a condition to receiving regulatory approval, which condition may not be acceptable to the Company or, if acceptable, may reduce the benefit of a proposed acquisition.

Under the Riegle-Neal Interstate Banking and Branching Efficiency Act, or the Riegle-Neal Act, a bank holding company may acquire banks in states other than its home state, subject to any state requirement that the bank has been organized and operating for a minimum period of time, not to exceed five years, and to certain deposit market-share limitations. Bank holding companies must be well capitalized and well managed, not merely adequately capitalized and adequately managed, in order to acquire a bank located outside of the bank holding company’s home state.

Control Acquisitions. Under the BHC Act, a company may not acquire “control” of a bank holding company or a bank without the prior approval of the Federal Reserve. The statute defines control as ownership or control of 25.0% or more of any class of voting securities, control of the election of a majority of the board of directors, or any other circumstances in which the Federal Reserve determines that a company directly or indirectly exercises a controlling influence over the management or policies of the bank holding company or bank. The BHC Act includes a presumption that control does not exist when a company owns or controls less than 5.0% of any class of voting securities. Companies that propose to acquire between 5.0% and 24.99% of any class of voting securities usually consult with the Federal Reserve in advance and often must make written commitments not to exercise control. As a matter of policy, the Federal Reserve has in a number of cases required a company to take certain actions to avoid control if the company proposes to acquire 25.0% or more but less than 33.3% of the total equity of a bank or bank holding company through the acquisition of both voting and non-voting shares, even if the voting shares are less than 25.0% of a class. The Federal Reserve generally deems the acquisition of 33.3% or more of the total equity of a bank or bank holding company to represent control. In March of 2020, the Federal Reserve published a final rule to revise its regulations related to determinations of whether a company has the ability to exercise a controlling influence over another company. The final rule expands the number of presumptions for use in such determinations and provides additional transparency on the types of relationships that the Federal Reserve generally views as supporting a determination of control.

The BHC Act does not apply to acquisitions by individuals or certain trusts, but if an individual, trust, or company proposes to acquire control of a bank or bank holding company, the Change in Bank Control Act, or CIBC Act, requires prior notice to the bank’s primary federal regulator or to the Federal Reserve in the case of a bank holding company. The CIBC Act uses a similar definition of control as the BHC Act, and agency regulations under the CIBC Act presume in many cases that a change in control occurs when an individual, trust, or company acquires 10.0% or more of any class of voting securities. The notice is not required for a company required to file an application under the BHC Act for the same transaction.

The requirements of the BHC Act and the CIBC Act could limit the Company’s access to capital and could limit parties who could acquire shares of the Company’s common stock.

Regulatory Restrictions on Payment of Dividends, Stock Redemptions, and Stock Repurchases. The Federal Reserve regulates the payment of dividends, stock redemptions, and stock repurchases by bank holding companies, including the Company. With respect to dividends, the Federal Reserve has issued a policy statement that provides that a bank holding company should not pay dividends unless: (i) its net income over the last four quarters (net of dividends paid) has been sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention appears to be consistent with the capital needs, asset quality and overall financial condition of the bank holding company and its subsidiaries; and (iii) the bank holding company will continue to meet minimum required capital adequacy ratios. Accordingly, the

Table

Company should not pay cash dividends that exceed its net income in any year or that can only be funded in ways that weaken its financial strength, including by borrowing money to pay dividends.

The Company is also subject to significant restrictions with respect to redemptions and repurchases of its securities. The Federal Reserve has issued guidance indicating that a bank holding company should not repurchase its common stock, preferred stock, trust preferred securities, or other regulatory capital instruments in the market if such action would be inconsistent with the bank holding company’s prospective capital needs and continued safe and sound operation. In certain circumstances, a bank holding company is also required to notify the Federal Reserve in advance of a proposed redemption of repurchase. For example, a bank holding company is generally required to notify the Federal Reserve of actions that would reduce the company’s consolidated net worth by 10.0% or more; most instruments included in Tier 1 capital with features permitting redemption at the option of the issuing bank holding company (e.g., perpetual preferred stock and trust preferred securities) may qualify as regulatory capital only if redemption is subject to prior Federal Reserve approval; and bank holding companies are generally required to consult with the Federal Reserve before redeeming any equity or other capital instrument included in Tier 1 or Tier 2 capital prior to stated maturity, if such redemption could have a material effect on the level or composition of the organization’s capital base. The Federal Reserve has also indicated that bank holding companies experiencing financial weaknesses (or at significant risk of developing financial weaknesses) or considering expansion (either through acquisitions or new activities) should consult with the Federal Reserve before redeeming or repurchasing common stock or other regulatory capital instruments for cash or other valuable consideration. In evaluating the appropriateness of a bank holding company’s proposed redemption or repurchase, the Federal Reserve will generally consider: (i) the potential losses that the company may suffer from the prospective need to increase reserves and write down assets from continued asset deterioration; (ii) the company’s ability to raise additional common stock and other Tier 1 capital to replace capital instruments that are redeemed or repurchased; and (iii) the potential negative effects on the company’s capital resulting from the replacement of common stock with lower-quality forms of regulatory capital or from the redemption or repurchase of capital instruments from investors with cash or other value that could be better used to strengthen the company’s regulatory capital base or its overall financial condition.

Source of Strength. Under Federal Reserve policy, bank holding companies have historically been required to act as a source of financial and managerial strength to each of their banking subsidiaries, and the Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. As discussed above, a bank holding company, in certain circumstances, could be required to guarantee the capital restoration plan of an undercapitalized banking subsidiary. If the capital of the Bank were to become impaired, the Federal Reserve could assess the Company for the deficiency. If the Company failed to pay the assessment within three months, the Federal Reserve could order the sale of the Company’s stock in the Bank to cover the deficiency.

In the event of a bank holding company’s bankruptcy under Chapter 11 of the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and will be required to cure immediately any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution, and any claim for breach of such obligation will generally have priority over most other unsecured claims.

Scope of Permissible Activities. Under the BHC Act, the Company may engage or acquire a company engaged solely in certain types of activities. Permissible activities include banking, managing or controlling banks or furnishing services to or performing services for the Bank, and certain activities found by the Federal Reserve to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. These activities include, among others, operating a mortgage, finance, credit card or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, nonoperating basis; and providing certain stock brokerage and investment advisory services. The BHC Act also permits certain other specific activities. To engage in such activities, the Company would in many cases be required to obtain the prior approval of the Federal Reserve. In its review of applications, the Federal Reserve considers, among other things, whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

Table

The Gramm-Leach-Bliley Act, effective March 11, 2000, or the GLB Act, expanded the scope of activities available to a bank holding company. The amendments allow a qualifying bank holding company to elect “financial holding company” status. A financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are “financial in nature.” Such activities include, among other things, securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve has determined to be closely related to banking. No regulatory approval is required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve. The Company qualifies for financial holding company status, but it has not made such an election. The Company will make such an election in the future if it plans to engage in any lines of business that are impermissible for bank holding companies but permissible for financial holding companies.

Safety and Soundness. Bank holding companies are not permitted to engage in unsafe or unsound practices. The Federal Deposit Insurance Act, or FDIA, requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of the FDIA. See “Prompt Corrective Action” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.  

The Federal Reserve has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound practices, result in breaches of fiduciary duty or which constitute violations of laws or regulations, and to assess civil money penalties or impose enforcement action for such activities. The penalties can be as high as $1.0 million for each day the activity continues.

Anti-tying Restrictions. Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other nonbanking services offered by a bank holding company or its affiliates.

CommunityBank of Texas, N.A.

The Bank is subject to various requirements and restrictions under the laws of the U.S. and to regulation, supervision and examination by the OCC. The Bank is also an insured depository institution and, therefore, subject to regulation by the FDIC, although the OCC is the Bank’s primary federal regulator. The OCC and the FDIC have the power to enforce compliance with applicable banking statutes and regulations. Such requirements and restrictions include requirements to maintain reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and restrictions relating to investments and other activities of the Bank.

Capital Adequacy Requirements. Under the Basel III Capital Rules, as discussed above, the OCC monitors the capital adequacy of the Bank by using a combination of risk-based guidelines and leverage ratios. The OCC considers the Bank’s capital levels when acting on various types of applications and when conducting supervisory activities related to the safety and soundness of the Bank and the banking system. Higher capital levels may be required if warranted by the circumstances or risk profiles of individual institutions, or if required by the banking regulators due to the economic conditions impacting the Company’s markets. For example, OCC regulations provide that higher capital may be required to take adequate account of, among other things, interest rate risk and the risks posed by concentrations of credit, nontraditional activities or securities trading activities.

Table

Corrective Measures for Capital Deficiencies. The federal banking regulators are required by the Federal Deposit Insurance Act, or FDI Act, to take “prompt corrective action” with respect to capital-deficient institutions that are FDIC-insured. Agency regulations define, for each capital category, the levels at which institutions are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” Under the current capital rules, which became effective on January 1, 2015, a well capitalized bank has a total risk-based capital ratio of 10.0% or higher, a Tier 1 risk-based capital ratio of 8.0% or higher, a leverage ratio of 5.0% or higher, a CET1 capital ratio of 6.5% or higher and is not subject to any written agreement, order or directive requiring it to maintain a specific capital level for any capital measure. An adequately capitalized bank has a total risk-based capital ratio of 8.0% or higher, a Tier 1 risk-based capital ratio of 6.0% or higher, a leverage ratio of 4.0% or higher, a CET1 capital ratio of 4.5% or higher and does not meet the criteria for a well capitalized bank. A bank is undercapitalized if it fails to meet any one of the ratios required to be adequately capitalized.

In addition to requiring undercapitalized institutions to submit a capital restoration plan, agency regulations contain broad restrictions on certain activities of undercapitalized institutions including asset growth, acquisitions, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment.

As a national bank’s capital decreases, the OCC is statutorily required to take increasingly severe actions against the bank. If a national bank is significantly undercapitalized, the OCC must, among other actions, require the bank to engage in capital raising activities, restrict interest rates paid by the bank, restrict the bank’s activities or asset growth, require the bank to dismiss certain directors and senior executive officers, restrict the bank’s transactions with its affiliates, or require the bank to divest itself of or liquidate certain subsidiaries. The OCC has very limited discretion in dealing with a critically undercapitalized national bank and is virtually required to appoint a receiver or conservator.

Banks with risk-based capital and leverage ratios below the required minimums may also be subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital.

Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.

Branching. National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which they are located. Under the Dodd-Frank Act, de novo interstate branching by national banks is permitted if, under the laws of the state where the branch is to be located, a state bank chartered in that state would have been permitted to establish a branch. Under current Texas law, state banks are permitted to establish branch offices throughout Texas with prior regulatory approval. In addition, with prior regulatory approval, state banks are permitted to acquire branches of existing banks located in Texas. State banks located in Texas may also branch across state lines by merging with banks or by purchasing a branch of another bank in other states if allowed by the applicable states’ laws.

Restrictions on Transactions with Affiliates and Insiders. Transactions between the Bank and its nonbanking subsidiaries and/or affiliates, including the Company, are subject to Section 23A and 23B of the Federal Reserve Act and Regulation W promulgated under such Sections. In general, Section 23A of the Federal Reserve Act imposes limits on the amount of such transactions and requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third-parties which are collateralized by the securities or obligations of the Company or its subsidiaries. Covered transactions with any single affiliate may not exceed 10.0% of the capital stock and surplus of the Bank, and covered transactions with all affiliates may not exceed, in the aggregate, 20.0% of the Bank’s capital and surplus. For a bank, capital stock and surplus refer to the bank’s Tier 1 and Tier 2 capital, as calculated under the risk-based capital guidelines, plus the balance of the allowance for credit losses, or ACL, excluded from Tier 2 capital. The Bank’s transactions with all of its affiliates in the aggregate are limited to 20.0% of the foregoing capital. “Covered transactions”

Table

are defined by statute to include a loan or extension of credit to an affiliate, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the Federal Reserve) from the affiliate, the acceptance of securities issued by the affiliate as collateral for a loan and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In addition, in connection with covered transactions that are extensions of credit, the Bank may be required to hold collateral to provide added security to the Bank, and the types of permissible collateral may be limited. The Dodd-Frank Act generally enhances the restrictions on transactions with affiliates, including an expansion of what types of transactions are covered transactions to include credit exposures related to derivatives, repurchase agreement and securities lending arrangements and an increase in the amount of time for which collateral requirements regarding covered transactions must be satisfied. Affiliate transactions are also subject to Section 23B of the Federal Reserve Act which generally requires that certain transactions between the Bank and its affiliates be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons.

The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to herein as “insiders”) contained in Section 22(h) of the Federal Reserve Act and in Regulation O promulgated by the Federal Reserve apply to all insured institutions and their subsidiaries and bank holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. Generally, the aggregate of these loans cannot exceed the institution’s total unimpaired capital and surplus, although a bank’s regulators may determine that a more stringent limit is appropriate. Loans to senior executive officers of a bank are even further restricted. Insiders are subject to monetary penalties for knowingly accepting loans in violation of applicable restrictions.

Restrictions on Distribution of Bank Dividends and Assets. Dividends paid by the Bank have provided a substantial part of the Company’s operating funds and for the foreseeable future it is anticipated that dividends paid by the Bank to the Company will continue to be the Company’s principal source of operating funds. Earnings and capital adequacy requirements serve to limit the amount of dividends that may be paid by the Bank. In general terms, federal law provides that the Bank’s board of directors may, from time to time and as it deems expedient, declare a dividend out of its net profits. Generally, the total of all dividends declared in a year shall not, unless approved by the OCC, exceed the net profits of that year combined with its net profits of the past two years.

In addition, under the Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, the Bank may not pay any dividend if it is undercapitalized or the payment of the dividend would cause it to become undercapitalized. The OCC may further restrict the payment of dividends by requiring that the Bank maintain a higher level of capital than otherwise required for it to be adequately capitalized for regulatory purposes. Moreover, if, in the opinion of the OCC, the Bank is engaged in an unsound practice (which could include the payment of dividends), it may require, generally after notice and hearing, that the Bank cease such practice. The OCC has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe banking practice. The OCC has also issued policy statements providing that insured depository institutions generally should pay dividends only out of current operating earnings.

Depositor Preference. In the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

Incentive Compensation Guidance. The federal banking agencies have issued comprehensive guidance on incentive compensation policies intended to help ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of those organizations by encouraging excessive risk-taking. The incentive compensation guidance sets expectations for banking organizations concerning their incentive compensation arrangements and related risk management, control and governance processes. The incentive compensation guidance, which covers all employees that can materially affect the risk profile of an organization, either individually or as part of a group, is based upon three primary principles: (i) balanced risk-taking incentives; (ii) compatibility with effective controls and risk management; and (iii) strong corporate governance. Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or take other actions. In addition, under the incentive compensation guidance, a banking organization’s federal supervisor may initiate

Table

enforcement action if the organization’s incentive compensation arrangements pose a risk to the safety and soundness of the organization. Further, a provision of the Basel III capital standards described above would limit discretionary bonus payments to bank executives if the institution’s regulatory capital ratios fail to exceed certain thresholds. A number of federal regulatory agencies proposed rules that would require enhanced disclosure of incentive-based compensation arrangements initially in April 2011 and again in April and May 2016. The scope and content of the U.S. banking regulators’ policies on executive compensation are continuing to develop and are likely to continue evolving in the near future.

Audits. For insured institutions with total assets of $500 million or more, financial statements prepared in accordance with accounting principles generally accepted in the U.S., or GAAP, as well as management’s certifications signed by the Company’s and the Bank’s chief executive officer and chief accounting or financial officer concerning management’s responsibility for the financial statements, must be submitted to the FDIC. If the insured institution has consolidated total assets of more than $1.0 billion, it must additionally submit an attestation by the auditors regarding the institution’s internal controls. Insured institutions with total assets of $500 million or more must also have an audit committee consisting exclusively of outside directors (the majority of whom must be independent of management), and insured institutions with total assets of $1.0 billion or more must have an audit committee that is entirely independent. The committees of institutions with total assets of more than $3.0 billion must include members with experience in banking or financial management, must have access to outside counsel and must not include representatives of large customers. The Bank’s audit committee consists entirely of independent directors and includes members with experience in banking or related financial management.

Deposit Insurance Assessments. The FDIC insures the deposits of federally insured banks up to prescribed statutory limits for each depositor through the Deposit Insurance Fund and safeguards the safety and soundness of the banking and thrift industries. The maximum amount of deposit insurance for banks and savings institutions is $250,000 per depositor, per ownership category. The amount of FDIC assessments paid by each insured depository institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors and is calculated based on an institution’s average consolidated total assets minus average tangible equity.

The Bank is generally unable to control the amount of premiums that it is required to pay for FDIC insurance. At least semi-annually, the FDIC will update its loss and income projections for the Deposit Insurance Fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking, if required. If there are additional bank or financial institution failures or if the FDIC otherwise determines to increase assessment rates, the Bank may be required to pay higher FDIC insurance premiums. Any future increases in FDIC insurance premiums may have a material and adverse effect on the Company’s earnings.

Financial Subsidiaries. Under the GLB Act, banks may establish financial subsidiaries and engage, subject to limitations on investment, in activities that are financial in nature, other than insurance underwriting as principal, insurance company portfolio investment, real estate development, real estate investment, annuity issuance and merchant banking activities. To do so, a bank must be well capitalized, well managed and have a CRA rating from its primary federal regulator of satisfactory or better. Banks with financial subsidiaries, as well as subsidiary banks of financial holding companies, must remain well capitalized and well managed to continue to engage in activities that are financial in nature without regulatory actions or restrictions. Such actions or restrictions could include divestiture of the “financial in nature” subsidiary or subsidiaries.

Brokered Deposit Restrictions. Insured depository institutions that are categorized as adequately capitalized institutions under the FDI Act and corresponding federal regulations cannot accept, renew or roll over brokered deposits without receiving a waiver from the FDIC and are subject to restrictions on the interest rates that can be paid on any deposits. Insured depository institutions that are categorized as undercapitalized institutions under the FDI Act and corresponding federal regulations may not accept, renew or roll over brokered deposits. The Bank is not currently subject to such restrictions.

Concentrated Commercial Real Estate Lending Regulations. The federal banking regulatory agencies have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank may be exposed to heightened commercial real estate lending concentration risk and subject to further supervisory analysis if (i) total reported loans for construction, land development and other land represent 100.0% or more of total capital or (ii) total reported loans secured by multi-family residential properties and nonfarm nonresidential properties and loans for construction, land development and other land represent 300.0% or more of total capital and the

Table

bank’s commercial real estate loan portfolio has increased by 50.0% or more during the prior 36 months. If a concentration is present, management is expected to employ heightened risk management practices that address, among other things, board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing and maintenance of increased capital levels as needed to support the level of commercial real estate lending.

Community Reinvestment Act. The CRA and regulations issued thereunder are intended to encourage banks to help meet the credit needs of their communities, including low- and moderate-income neighborhoods, consistent with safe and sound operations. The CRA and implementing regulations provide for, among other things, regulatory assessment of a bank’s record in meeting the needs of its entire community when considering applications by the bank to establish branches, merge or consolidate with another bank, or acquire the assets and assume the liabilities of another bank. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application by the bank holding company to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. The CRA, as amended by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, requires federal banking agencies to make public a rating of a bank’s performance under the CRA. An unsatisfactory CRA rating could substantially delay approval or result in denial of an application. The Bank received an “Outstanding” rating on its most recent CRA performance evaluation.

Consumer Laws and Regulations. The Bank is subject to numerous federal laws and regulations intended to protect consumers in transactions with the Bank, including but not limited to the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Real Estate Procedures Act of 1974, the S.A.F.E. Mortgage Licensing Act of 2008, the Truth in Lending Act, the Truth in Savings Act and laws prohibiting unfair, deceptive or abusive acts and practices in connection with consumer financial products and services. Many states and local jurisdictions have consumer protection laws analogous and in addition to those enacted under federal law. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans and conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, customer rescission and registration rights, action by state and local attorneys general and civil or criminal liability.

The authority to supervise and examine depository institutions with $10.0 billion or less in assets for compliance with federal consumer laws remains largely with those institutions’ primary regulators (the OCC, in the case of the Bank). However, the CFPB may participate in examinations of these smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. Accordingly, the CFPB may participate in examinations of the Bank, which currently has assets of less than $10.0 billion, and could supervise and examine the Company’s other direct or indirect subsidiaries that offer consumer financial products or services.

Mortgage Lending Rules. CFPB regulations that require lenders to determine whether a consumer has the ability to repay a mortgage loan became effective on January 10, 2014. These regulations established certain minimum requirements for creditors when making ability-to-repay determinations and provide certain safe harbors from liability for mortgages that are “qualified mortgages” and are not “higher-priced.” Generally, these CFPB regulations apply to all consumer, closed-end loans secured by a dwelling, including home-purchase loans, refinancing and home equity loans (whether first or subordinate lien). Qualified mortgages must generally satisfy detailed requirements related to product features, underwriting standards, and requirements where the total points and fees on a mortgage loan cannot exceed specified amounts or percentages of the total loan amount. Qualified mortgages must: (i) have a term not exceeding 30 years; (ii) provide for regular periodic payments that do not result in negative amortization, deferral of principal repayment, or a balloon payment; and (iii) be supported with documentation of the borrower and his or her credit worthiness.

The Regulatory Relief Act included a provision that provides for certain residential mortgages held in portfolio by banks with less than $10.0 billion in consolidated assets to automatically be deemed “qualified mortgages.” This relieves such institutions from many of the requirements to satisfy the criteria listed above for “qualified mortgages.” Mortgages meeting the “qualified mortgage” safe harbor may not have negative amortization, must follow prepayment penalty limitations included in the Truth in Lending Act, and may not have fees greater than three percent of the total value of the loan.

Anti-Money Laundering and Office of Foreign Assets Control. A major focus of governmental policy on banks and other financial institutions in recent years has been combating money laundering and terrorist financing. The Bank Secrecy Act, or BSA, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and

Table

Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, and other federal laws impose significant obligations on certain financial institutions, including the Bank, to detect and deter money laundering and terrorist financing. The principal obligations of an insured depository institution include, among other things, the need to: (i) establish an anti-money laundering, or AML, program that includes training and audit components; (ii) designate a BSA officer; (iii) establish a “know your customer” program involving due diligence to confirm the identity of persons seeking to open accounts and to deny accounts to those persons unable to demonstrate their identities; (iv) identify and verify the identity of beneficial owners of legal entity customers, subject to certain exclusions and exemptions; (v) take additional precautions with respect to customers that pose heightened risk; (vi) monitor, investigate and report suspicious transactions or activity; (vii) file currency transaction reports for deposits and withdrawals of large amounts of cash; (viii) verify and certify money laundering risk with respect to private banking and foreign correspondent banking relationships; (ix) maintain records for certain minimum periods of time; and (x) respond to requests for information by law enforcement. The Financial Crimes Enforcement Network, or FinCEN, and the federal banking regulators have imposed significant civil money penalties against banks found to be violating these obligations.

​

The Office of Foreign Assets Control, or OFAC, administers laws and Executive Orders that prohibit U.S. entities from engaging in transactions with certain prohibited parties. OFAC publishes lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. Generally, if a bank identifies a transaction, account or wire transfer relating to a person or entity on an OFAC list, it must freeze the account or block the transaction, file a suspicious activity report and notify the appropriate authorities.

​

Bank regulators routinely examine institutions for compliance with these obligations and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for bank mergers and acquisitions. In addition, other government agencies have the authority to conduct investigations of an institution’s compliance with these obligations. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing and comply with OFAC sanctions, or to comply with relevant laws and regulations, could have serious legal, reputational and financial consequences for the institution.

On June 18, 2020, the Bank and the OCC entered into a formal agreement, or the Formal Agreement, with regard to BSA/AML compliance matters. On September 7, 2021, the Company was informed by the OCC that it terminated the Formal Agreement, between the Bank and the OCC.  

​

On December 16, 2021, the Bank, entered into a consent order with the Office of the Comptroller of the Currency, or OCC, regarding BSA/AML compliance matters, or OCC Consent Order. Under the OCC Consent Order, the Bank paid a civil money penalty of $1.0 million.

On December 15, 2021, the Bank entered into a consent order with FinCEN regarding BSA compliance matters, or the FinCEN Consent Order. Under the terms of the FinCEN Consent Order, the Bank paid a civil money penalty of $8.0 million; provided, however, that FinCEN agreed to credit the Bank the $1.0 million civil money penalty imposed by the OCC described above. As a result, the Bank paid an aggregate sum of $8.0 million under both the OCC Consent Order and the FinCEN Consent Order. The OCC Consent Order and the FinCEN Consent Order each respectively settle the civil money proceedings against the Bank initiated by the OCC and FinCEN.

​

Privacy. The federal banking regulators have adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to non-affiliated third-parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a non-affiliated third-party. These regulations affect how consumer information is transmitted through financial services companies and conveyed to outside vendors. In addition, consumers may also prevent disclosure of certain information among affiliated companies that is assembled or used to determine eligibility for a product or service, such as that shown on consumer credit reports and asset and income information from applications. Consumers also have the option to direct banks and other financial institutions not to share information about transactions and experiences with affiliated companies for the purpose of marketing products or services. In addition to applicable federal privacy regulations, the Bank is subject to certain state privacy laws.

Federal Home Loan Bank System. The Federal Home Loan Bank System, of which the Bank is a member, is composed of 12 regional Federal Home Loan Banks, more than 8,000 member financial institutions, and a fiscal agent. The Federal Home Loan Banks provide long- and short-term advances (i.e., loans) to member institutions within their assigned regions in accordance with policies and procedures established by the boards of directors of each regional Federal

Table

Home Loan Bank. Such advances are primarily collateralized by residential mortgage loans, as well as government and agency securities, and are priced at a small spread over comparable U.S. Department of the Treasury obligations.

As a member of the Federal Home Loan Bank of Dallas, or the FHLB Dallas, the Bank is entitled to borrow from the FHLB Dallas, provided it posts acceptable collateral. The Bank is also required to own a certain amount of capital stock in the FHLB Dallas. The Bank is in compliance with the stock ownership rules with respect to such advances, commitments and letters of credit and collateral requirements with respect to home mortgage loans and similar obligations. All loans, advances and other extensions of credit made by the FHLB Dallas to the Bank are secured by a portion of the respective mortgage loan portfolio, certain other investments and the capital stock of the FHLB Dallas held by the Bank.

Enforcement Powers. The federal banking agencies, including the Bank’s primary federal regulator, the OCC, have broad enforcement powers, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties and appoint a conservator or receiver. Failure to comply with applicable laws, regulations and supervisory agreements, breaches of fiduciary duty or the maintenance of unsafe and unsound conditions or practices could subject the Company or the Bank and their subsidiaries, as well as their respective officers, directors and other institution-affiliated parties, to administrative sanctions and potentially substantial civil money penalties. For example, the regulatory authorities may appoint the FDIC as conservator or receiver for a banking institution (or the FDIC may appoint itself, under certain circumstances) if any one or more of a number of circumstances exist, including, without limitation, the fact that the banking institution is undercapitalized and has no reasonable prospect of becoming adequately capitalized, fails to become adequately capitalized when required to do so, fails to submit a timely and acceptable capital restoration plan or materially fails to implement an accepted capital restoration plan.

Effect of Governmental Monetary Policies

The commercial banking business is affected not only by general economic conditions but also by U.S. fiscal policy and the monetary policies of the Federal Reserve. Some of the instruments of monetary policy available to the Federal Reserve include changes in the discount rate on member bank borrowings, the fluctuating availability of borrowings at the “discount window,” open market operations, the imposition of and changes in reserve requirements against member banks’ deposits and certain borrowings by banks and their affiliates and assets of foreign branches. These policies influence, to a significant extent, the overall growth of bank loans, investments, deposits and the interest rates charged on loans or paid on deposits. The Company cannot predict the nature of future fiscal and monetary policies or the effect of these policies on the Company’s operations and activities, financial condition, results of operations, growth plans or future prospects.

Impact of Current Laws and Regulations

The cumulative effect of these laws and regulations, while providing certain benefits, adds significantly to the cost of the Company’s operations and thus may have a negative impact on its profitability. There has also been a notable expansion in recent years of financial service providers that are not subject to the examination, oversight and other rules and regulations to which the Company is subject. Those providers, because they are not so highly regulated, may have a competitive advantage over the Company and may continue to draw large amounts of funds away from traditional banking institutions, with a continuing adverse effect on the banking industry in general.

Implications of Being an Emerging Growth Company

As a company with less than $1.07 billion in total annual gross revenues during its last fiscal year and satisfying other applicable standards, the Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of reduced reporting and other requirements that are otherwise generally applicable to public companies. Emerging growth company are:

Table

The Company has elected to take advantage of the scaled disclosures and other relief described above in this Annual Report on Form 10-K, and may take advantage of these exemptions until December 31, 2022 or such earlier time that it is are no longer an “emerging growth company.” In general, the Company would cease to be an “emerging growth company” if it had $1.07 billion or more in annual revenues, more than $700 million in market value of its common stock held by non-affiliates on any June 30 more than one year after its initial public offering, or issued more than $1.0 billion of non-convertible debt over a three-year period. As a result, the Company could cease to be an “emerging growth company” as soon as the end of the 2022 year. For so long as the Company may choose to take advantage of some or all of these reduced burdens, the level of information that it provides shareholders may be different than what shareholders might get from other public companies in which they hold stock. In addition, when these exemptions cease to apply, the Company expects to incur additional expenses and devote increased management effort toward ensuring compliance with them, which the Company may not be able to predict or estimate.

Future Legislation and Regulatory Reform

In recent years, regulators have increased their focus on the regulation of financial institutions. From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating in the U.S. The Company cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which its business may be affected by any new regulation or statute. Future legislation, regulation and policies and the effects of such legislation, regulation and policies, may have a significant influence on the Company’s operations and activities, financial condition, results of operations, growth plans or future prospects and the overall growth and distribution of loans, investments and deposits. Such legislation, regulation and policies have had a significant effect on the operations and activities, financial condition, results of operations, growth plans and future prospects of commercial banks in the past and are expected to continue to do so.

Item 1A. Risk Factors

Summary of Risk Factors

The Company’s business is subject to a number of risks, including risks that may prevent it from achieving its business objectives or may adversely affect its business, reputation, financial condition, results of operations, revenue and future prospects. These risks are discussed more fully in “Item 1A.—Risk Factors” of this Annual Report on Form 10-K. These risks include, but are not limited to, the following:

Risks Related to the COVID-19 Pandemic

Risks Related to the Pending Merger

Table

Risks Related to the Company’s Business and Operations

Risks Related to the Economy and the Company’s Industry

​

Risks Related to Cybersecurity, Third-Parties and Technology

Risks Related to Legal, Reputational and Compliance Matters

Table

Risks Related to the Regulation of the Company’s Industry

Risks Related to Ownership of the Company’s Common Stock

Risk Factors

The Company’s business involves significant risks, some of which are described below. Shareholders should carefully consider the risks and uncertainties described below, together with all the other information in this Annual Report on Form 10-K including “Part II.—Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes in “Part II.—Item 8.—Financial Statements and Supplementary Data.” If any of the following risks occur, the Company’s business, reputation, financial condition, results of operations, revenue and future prospects could be seriously harmed. As a result, the trading price of the Company’s common stock could decline, and shareholders could lose all or part of their investment. Some statements in this Annual Report on Form 10-K, including statements in the following risk factors section, constitute forward-looking statements. Please refer to “Cautionary Note Regarding Forward-Looking Statements” and “Part II.—Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.

Risks Related to the COVID-19 Pandemic

The COVID-19 pandemic has and will likely continue to adversely impact the Company’s business, and the ultimate impact on the business and financial results will depend on future developments, which are highly uncertain and cannot be predicted.

The COVID-19 pandemic created extensive disruptions to the global economy and to the lives of individuals throughout the world. While the scope, duration, and full effects of COVID-19  remain uncertain and cannot be predicted, the pandemic and related efforts to contain it disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest prices, increased economic and market uncertainty, and disrupted trade and supply chains. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, the Company is subject to many risks, including but not limited to:

Table

The future impact of the COVID-19 pandemic is uncertain but could materially affect the Company’s future financial and operational results.

Risks Related to the Proposed Merger

Because the market price of the Company’s common stock may fluctuate, holders of Allegiance common stock cannot be certain of the market value of the merger consideration they will receive.

​

In the merger, each share of Allegiance common stock issued and outstanding immediately prior to the effective time (other than certain shares held by the Company or Allegiance) will be converted into 1.4184 shares of the Company’s common stock. This exchange ratio is fixed and will not be adjusted for changes in the market price of either the Company’s common stock or Allegiance common stock. Changes in the price of the Company’s common stock prior to the merger will affect the value that holders of Allegiance common stock will receive in the merger. Neither the Company nor Allegiance is permitted to terminate the merger agreement as a result, in and of itself, of any increase or decrease in the market price of the Company’s common stock or Allegiance common stock.

​

Stock price changes may result from a variety of factors, including general market and economic conditions, changes in the Company’s or Allegiance’s businesses, operations and prospects and regulatory considerations, many of which factors are beyond the Company’s or Allegiance’s control. Therefore, at the time of the Company’s special meeting and the Allegiance special meeting, holders of the Company’s common stock and holders of Allegiance common stock will not know the market value of the consideration to be received by holders of Allegiance common stock at the effective time. Investors should obtain current market quotations for shares of the Company’s common stock and for shares of Allegiance common stock.

​

The market price of the Company’s common stock after the merger may be affected by factors different from those affecting shares of Allegiance common stock or the Company’s common stock currently.

​

In the merger, holders of Allegiance common stock will become holders of the Company’s common stock. The Company’s business differs from that of Allegiance. Accordingly, the results of operations of the combined company and the market price of the Company’s common stock after the completion of the merger may be affected by factors different from those currently affecting the independent results of operations of each of the Company and Allegiance.

The Company and Allegiance are expected to incur substantial costs related to the merger and integration.

​

The Company and Allegiance have incurred and expect to incur a number of non-recurring costs associated with the merger. These costs include legal, financial advisory, accounting, consulting and other advisory fees, severance/employee benefit-related costs, public company filing fees and other regulatory fees, financial printing and other printing costs and other related costs. Some of these costs are payable by either the Company or Allegiance regardless of whether or not the merger is completed.

​

Table

The combined company is expected to incur substantial costs in connection with the related integration. There are a large number of processes, policies, procedures, operations, technologies and systems that may need to be integrated, including core processing, accounting and finance, payroll, compliance, treasury management, branch operations, vendor management, risk management, lines of business, pricing and benefits. While Allegiance and the Company have assumed that a certain level of costs will be incurred, there are many factors beyond their control that could affect the total amount or the timing of the integration costs. Moreover, many of the costs that will be incurred are, by their nature, difficult to estimate accurately. These integration costs may result in the combined company taking charges against earnings following the completion of the merger, and the amount and timing of such charges are uncertain at present.

​

Combining the Company and Allegiance may be more difficult, costly or time consuming than expected and the Company and Allegiance may fail to realize the anticipated benefits of the merger.

​

The success of the merger will depend, in part, on the ability to realize the anticipated cost savings from combining the businesses of the Company and Allegiance. To realize the anticipated benefits and cost savings from the merger, the Company and Allegiance must successfully integrate and combine their businesses in a manner that permits those cost savings to be realized. If the Company and Allegiance are not able to successfully achieve these objectives, the anticipated benefits of the merger may not be realized fully or at all or may take longer to realize than expected. In addition, the actual cost savings and anticipated benefits of the merger could be less than anticipated, and integration may result in additional unforeseen expenses.

​

The Company and Allegiance have operated and, until the completion of the merger, must continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the disruption of each company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the companies’ ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the merger. Integration efforts between the two companies may also divert management attention and resources. These integration matters could have an adverse effect on each of the Company and Allegiance during this transition period and for an undetermined period after completion of the merger on the combined company.

​

The future results of the combined company following the merger may suffer if the combined company does not effectively manage its expanded operations.

​

Following the merger, the size of the business of the combined company will increase significantly beyond the current size of either the Company’s or Allegiance’s business. The combined company’s future success will depend, in part, upon its ability to manage this expanded business, which may pose challenges for management, including challenges related to the management and monitoring of new operations and associated increased costs and complexity. The combined company may also face increased scrutiny from governmental authorities as a result of the significant increase in the size of its business. There can be no assurances that the combined company will be successful or that it will realize the expected operating efficiencies, cost savings, revenue enhancements or other benefits currently anticipated from the merger.

​

The combined company may be unable to retain the Company’s or Allegiance’s personnel successfully after the merger is completed.

​

The success of the merger will depend in part on the combined company’s ability to retain the talents and dedication of key employees currently employed by the Company and Allegiance. It is possible that these employees may decide not to remain with the Company or Allegiance, as applicable, while the merger is pending or with the combined company after the merger is consummated. If the Company and Allegiance are unable to retain key employees, including management, who are critical to the successful integration and future operations of the companies, the Company and Allegiance could face disruptions in their operations, loss of existing customers, loss of key information, expertise or know-how and unanticipated additional recruitment costs. In addition, if key employees terminate their employment, the combined company’s business activities may be adversely affected and management’s attention may be diverted from successfully integrating the Company and Allegiance to hiring suitable replacements, all of which may cause the combined company’s business to suffer. In addition, the Company and Allegiance may not be able to identify or retain suitable replacements for any key employees who leave either company.

Table

​

Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or that could have an adverse effect on the combined company following the merger.

​

Before the merger and the bank merger may be completed, various approvals, consents and non-objections must be obtained from the Federal Reserve Board, the FDIC, the Texas Department of Banking and other authorities in the United States. These approvals could be delayed or not obtained at all, including due to an adverse development in either party’s regulatory standing, or any other factors considered by regulators in granting such approvals; governmental, political or community group inquiries, investigations or opposition; or changes in legislation or the political environment.

​

The approvals that are granted may impose terms and conditions, limitations, obligations or costs, or place restrictions on the conduct of the combined company’s business or require changes to the terms of the transactions contemplated by the merger agreement. There can be no assurance that regulators will not impose any such conditions, limitations, obligations or restrictions and that such conditions, limitations, obligations or restrictions will not have the effect of delaying the completion of any of the transactions contemplated by the merger agreement, imposing additional material costs on or materially limiting the revenues of the combined company following the merger or otherwise reduce the anticipated benefits of the merger if the merger were consummated successfully within the expected timeframe. In addition, there can be no assurance that any such conditions, limitations, obligations or restrictions will not result in the delay or abandonment of the merger. Additionally, the completion of the merger is conditioned on the absence of certain orders, injunctions or decrees by any court or regulatory agency of competent jurisdiction that would prohibit or make illegal the completion of any of the transactions contemplated by the merger agreement.

​

Despite the parties’ commitments to use their reasonable best efforts to respond to any request for information and resolve any objection that may be asserted by any governmental entity with respect to the merger agreement, under the terms of the merger agreement, neither the Company nor Allegiance is required to take any action or agree to any condition or restriction in connection with obtaining these approvals that would reasonably be expected to have a material adverse effect on the combined company and its subsidiaries, taken as a whole, after giving effect to the merger.

​

Termination of the merger agreement could negatively affect the Company.

​

If the merger is not completed for any reason, including as a result of the Company’s shareholders failing to approve the Company’s merger proposal or Allegiance shareholders failing to approve the Allegiance merger proposal, there may be various adverse consequences and the Company and/or Allegiance may experience negative reactions from the financial markets and from their respective customers and employees. For example, the Company’s or Allegiance’s businesses may have been affected adversely by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger. Additionally, if the merger agreement is terminated, the market price of the Company’s or Allegiance’s common stock could decline to the extent that the current market prices reflect a market assumption that the merger will be completed. If the merger agreement is terminated under certain circumstances, either the Company or Allegiance may be required to pay a termination fee of $32.5 million to the other party.

​

Additionally, each of the Company and Allegiance has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the merger agreement, including certain outside consulting costs relating to integration preparation, as well as the costs and expenses of filing, printing and mailing this joint proxy statement/prospectus, and all filing and other fees paid to the SEC in connection with the merger. If the merger is not completed, the Company and Allegiance would have to pay these expenses without realizing the expected benefits of the merger.

​

The Company will be subject to business uncertainties and contractual restrictions while the merger is pending.

​

Uncertainty about the effect of the merger on employees and customers may have an adverse effect on the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel until the merger is completed, and could cause customers and others that deal with the Company to seek to change existing business relationships with the Company. In addition, subject to certain exceptions, the Company and Allegiance

Table

have agreed to operate their respective businesses in the ordinary course prior to closing, which could cause the Company to be unable to pursue other beneficial opportunities that may arise prior to the completion of the merger.

​

The shares of the Company’s common stock to be received by holders of Allegiance common stock as a result of the merger will have different rights from shares of Allegiance common stock.

​

In the merger, holders of Allegiance common stock will become holders of the Company’s common stock and their rights as shareholders will be governed by Texas law and the governing documents of the combined company. The rights associated with the Company’s common stock are different in some respects from the rights associated with Allegiance common stock.

In connection with the merger, the Company will assume certain of Allegiance’s outstanding debt obligations, and the combined company’s level of indebtedness following the completion of the merger could adversely affect the combined company’s ability to raise additional capital and to meet its obligations under its existing indebtedness.

​

In connection with the merger, the Company will assume certain of Allegiance’s outstanding indebtedness, including trust preferred securities, which consist of junior subordinated debentures with an aggregate original principal amount of $11.3 million and a current carrying value of $9.7 million at September 30, 2021, and $60.0 million aggregate principal amount of fixed-to-floating rate subordinated notes due October 1, 2029. Allegiance Bank also has outstanding $40.0 million aggregate principal amount of fixed-to-floating rate subordinated notes due December 15, 2027 that will be obligations of the combined bank. The Company’s existing debt, together with any future incurrence of additional indebtedness, and the assumption of Allegiance’s outstanding indebtedness, could have important consequences for the combined company’s shareholders. For example, it could:

​

Holders of the Company’s common stock and holders of Allegiance common stock will have a reduced ownership and voting interest in the combined company after the merger and will exercise less influence over management.

​

Holders of the Company’s common stock and holders of Allegiance common stock currently have the right to vote in the election of the board of directors and on other matters affecting the Company and Allegiance, respectively. When the merger is completed, each holder of Allegiance common stock who receives shares of the Company’s common stock will become a holder of common stock of the Company, with a percentage ownership of the combined company that is smaller than the holder’s percentage ownership of Allegiance. Based on the number of shares of the Company and Allegiance common stock outstanding as of the close of business on the respective record dates, and based on the number of shares of the Company’s common stock expected to be issued in the merger, the former holders of Allegiance common stock, as a group, are estimated to own approximately 54% of the fully diluted shares of the combined company immediately after the merger and current holders of the Company’s common stock as a group are estimated to own approximately 46% of the fully diluted shares of the combined company immediately after the merger. Because of this, holders of Allegiance common stock may have less influence on the management and policies of the combined company than they now have on the management and policies of Allegiance, and holders of the Company’s common stock may have less influence on the management and policies of the combined company than they now have on the management and policies of the Company.

​

​

Table

The issuance of shares of the Company’s common stock in connection with the merger may adversely affect the market price of the Company’s common stock.

​

In connection with the payment of the merger consideration, the Company expects to issue more than one million shares of the Company’s common stock to Allegiance shareholders. The issuance of these new shares of the Company’s common stock may result in fluctuations in the market price of the Company’s common stock, including a stock price decrease.

​

Holders of the Company’s common stock will not have appraisal rights or dissenters’ rights in the merger.

​

Appraisal rights (also known as dissenters’ rights) are statutory rights that, if applicable under law, enable shareholders to dissent from an extraordinary transaction, such as a merger, and to demand that the corporation pay the fair value for their shares as determined by a court in a judicial proceeding instead of receiving the consideration offered to shareholders in connection with the extraordinary transaction.

​

Under Section 10.354 of the TBOC, the holders of the Company’s common stock and the holders of Allegiance common stock will not be entitled to appraisal or dissenters’ rights in connection with the merger if, on the record date for the applicable special meeting, such shares of common stock are listed on a national securities exchange or held of record by more than 2,000 shareholders, holders of such common stock are not required to accept as consideration for their shares any consideration that is different from the consideration to be provided to any other holder of such common stock, other than cash instead of fractional shares, and holders of such common stock are not required to accept as consideration for their shares anything other than the shares of a domestic (Texas) entity which immediately after the effective date of the merger are either listed on a national securities exchange or held of record by more than 2,000 shareholders, cash paid in lieu of fractional shares or any combination of the foregoing.

​

The Company’s common stock is currently listed on the Nasdaq Global Select Market, a national securities exchange, and was so listed on the record date for the Company’s special meeting. If the merger is completed, holders of the Company’s common stock will not receive any consideration, and their shares of the Company’s common stock will remain outstanding and will constitute shares of the combined company, which shares are expected to continue to be listed on the Nasdaq Global Select Market at the effective time of the merger. Accordingly, holders of the Company’s common stock are not entitled to any appraisal or dissenters’ rights in connection with the merger.

​

Allegiance common stock is currently listed on the Nasdaq Global Market, a national securities exchange, and was so listed on the record date for the Allegiance special meeting. In addition, the holders of Allegiance common stock will receive shares of the Company’s common stock as consideration in the merger, which shares are currently listed on the Nasdaq Global Select Market, and are expected to continue to be so listed at the effective time. Accordingly, the holders of Allegiance common stock are not entitled to any appraisal or dissenters’ rights in connection with the merger.

​

Shareholder litigation could prevent or delay the closing of the merger or otherwise negatively affect the business and operations of the Company and Allegiance.

​

The Company and Allegiance may incur costs in connection with the defense or settlement of any shareholder lawsuits filed in connection with the merger. Such litigation could have an adverse effect on the financial condition and results of operations of the Company and Allegiance and could prevent or delay the consummation of the merger.

​

The merger agreement limits the Company’s ability to pursue alternatives to the merger and may discourage other companies from trying to acquire the Company.

​

The merger agreement contains “no shop” covenants that restrict each of the Company’s and Allegiance’s ability to, directly or indirectly, initiate, solicit, knowingly encourage or knowingly facilitate any inquiries or proposals with respect to any acquisition proposal, engage or participate in any negotiations with any person concerning any acquisition proposal, provide any confidential or nonpublic information or data to, or have or participate in any discussions with, any person relating to any acquisition proposal, subject to certain exceptions, or, unless the merger agreement has been terminated in accordance with its terms, approve or enter into any term sheet,

Table

letter of intent, commitment, memorandum of understanding, agreement in principle, acquisition agreement, merger agreement or other agreement in connection with or relating to any acquisition proposal.

​

The merger agreement further provides that, during the 12-month period following the termination of the merger agreement under specified circumstances, including the entry into a definitive agreement or consummation of a transaction with respect to an alternative acquisition proposal, the Company or Allegiance may be required to pay to the other party a cash termination fee equal to $32.5 million.

​

These provisions could discourage a potential third-party acquirer that might have an interest in acquiring all or a significant portion of the Company from considering or proposing that acquisition.

​

The merger agreement subjects the Company to certain restrictions on its business activities prior to the effective time.

​

The merger agreement subjects the Company and Allegiance to certain restrictions on their respective business activities prior to the effective time. The merger agreement obligates each of the Company and Allegiance to, and to cause each of its subsidiaries to, subject to certain specified exceptions, conduct its business in the ordinary course in all material respects and use reasonable best efforts to maintain and preserve intact its business organization, employees and advantageous business relationships. These restrictions could prevent the Company from pursuing certain business opportunities that arise prior to the effective time and are outside the ordinary course of business.

Risks Related to Business and Operations

The Company’s business is concentrated in and largely dependent upon the continued growth and welfare of its markets and on the banking industry in general.

The Company’s business is concentrated in the Houston and Beaumont, Texas markets and it entered the Dallas, Texas market in 2019. The Company’s success depends, to a significant extent, upon the economic activity and conditions in its markets. Adverse economic conditions that impact the Company’s markets could reduce its growth rate, the ability of customers to repay their loans, the value of collateral underlying loans, the Company’s ability to attract deposits and generally impact its business, financial condition, results of operations and future prospects. Due to the Company’s geographic concentration, it may be less able than other larger regional or national financial institutions to diversify the Company’s credit risks.

A national economic downturn or deterioration of conditions in the Company’s market, such as the COVID-19 pandemic or the sustained instability of the oil and gas industry, could adversely impact the Company’s borrowers and cause losses beyond those that are provided for in its ACL due to increases in loan delinquencies, nonperforming assets, foreclosures, loan charge-offs and decreases in demand for its products and services, which could adversely impact the Company’s liquidity position and decrease the value of the collateral. Increased economic uncertainty and increased unemployment resulting from the economic impacts of the spread of COVID-19 may also result in borrowers seeking sources of liquidity, withdrawing deposits and drawing down credit commitments at rates greater than previously expected. In addition, the effects of the COVID-19 pandemic, including actions taken by individuals, businesses, government agencies and others in response to the COVID-19 pandemic, may aggravate the impact of the risk factors discussed herein on the Company’s business.

The Company may not be able to adequately measure and limit its credit risk, which could lead to unexpected losses.

The business of lending is inherently risky, including risks that the principal of or interest on any loan will not be repaid timely or at all or that the value of any collateral supporting the loan will be insufficient to cover outstanding exposure. These risks may be affected by the strength of the borrower’s business sector and local, regional and national market and economic conditions. The Company’s risk management practices, such as monitoring the concentration of its loans within specific industries and credit approval practices, may not adequately reduce credit risk and credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of the loan portfolio. Failure to effectively measure and limit the credit risk associated with the Company’s loan portfolio could lead to unexpected losses.

The Company maintains an ACL that represents management’s judgment of expected losses and risks of losses inherent in its loan portfolio. The determination of the appropriate level of the ACL is inherently highly subjective and

Table

requires significant estimates of and assumptions regarding current credit risks, future trends and forecasts, all of which may undergo material changes. Inaccurate management assumptions, deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification or deterioration of additional problem loans, acquisition of problem loans, significant changes in forecasted periods and other factors, both within and outside of the Company’s control, may require an increase of its ACL.

In addition, regulators, as an integral part of their periodic examinations, review the Company’s methodology for calculating and the adequacy of its ACL and may direct the Company to make additions to the allowance based on their judgments about information available to them at the time of their examination. Further, if actual charge-offs in future periods exceed the amounts allocated to the ACL, the Company may need additional provisions for credit losses to restore the adequacy of its ACL.

The amount of nonperforming and classified assets may increase significantly, resulting in additional losses and costs and expenses.

The Company’s nonperforming assets include nonaccrual loans and assets acquired through foreclosure. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations when they become due. The resolution of nonperforming assets requires significant commitments of time from management, which may materially and adversely impact their ability to perform their other responsibilities. While the Company seeks to reduce problem assets through loan workouts, restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition and any increase in the amount of nonperforming or classified assets could have a material impact on the Company’s business, financial condition and results of operations, including through increased capital requirements from regulators.

The small to medium-sized businesses that the Company lends to may have fewer resources to endure adverse business developments, which may impair its borrowers’ ability to repay loans.

The Company focuses its business development and marketing strategy primarily on small to medium-sized businesses. Small to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the collateral securing such loans generally includes real property and general business assets, which may decline in value more rapidly than anticipated, exposing the Company to increased credit risk.

The Company’s primary markets in Houston, Beaumont and Dallas experienced limitations on commercial activity since the outbreak of COVID-19. Many businesses, particularly those in the Company’s primary markets, were subject to shutdowns at the onset of the pandemic and may become subject to additional shutdowns and restrictions if  COVID-19 cases increase. These challenging market conditions in which borrowers operate could cause declines in loan collectability and the values associated with general business assets, resulting in inadequate collateral coverage that may expose the Company to credit losses and could adversely affect its business, financial condition and results of operations. Moreover, the success of a small and medium-sized business often depends on the management skills, talents and efforts of a small group of people and the health, death, disability or resignation of one or more of the key management team, the inefficiency caused by remote working or the limited availability to work due to health concerns in response to COVID-19 could have an adverse impact on borrower’s businesses and their ability to repay their loans.

The Company participates in the small business loan program under the CARES Act, which may further expose it to credit losses from borrowers under such programs.

Among other components, the CARES Act provides for payment forbearance on mortgages or loans to borrowers experiencing a hardship during the COVID-19 pandemic. The Bank offered deferral and forbearance plans and  participated in the PPP by making loans to small businesses consistent with the CARES Act that are fully guaranteed by the Small Business Administration, or SBA. Various governmental programs such as the PPP are complex and the Company’s participation may lead to additional litigation and governmental, regulatory and third-party scrutiny, negative publicity and damage to its reputation. In addition, participation in the PPP as a lender may adversely affect the Company’s revenue and results of operations depending on the timing and amount of forgiveness, if any, to which borrowers will be entitled and the Company is subject to the risk of PPP fraud cases.

Table

The Company is subject to risks arising from loans in its loan portfolio with real estate as a primary or secondary component of collateral.

As of December 31, 2021, $2.1 billion, or 73.6%, of the Company’s gross loans were loans with real estate as a primary or secondary component of collateral. Real estate values in many Texas markets have experienced periods of fluctuation and can fluctuate significantly in a short period. Adverse developments affecting real estate values and the liquidity could increase the credit risk associated with the Company’s loan portfolio, cause it to increase the ACL, significantly impair the value of property pledged as collateral on loans and affect the ability to sell the collateral upon foreclosure without additional losses.

As of December 31, 2021, $1.4 billion, or 48.0%, of the Company’s gross loans were nonresidential real estate loans (commercial real estate loans and multi-family residential loans). These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. The availability of such income for repayment may be adversely affected by changes in the economy or local market conditions. As of December 31, 2021, the Company’s nonresidential real estate loans included $545.7 million of owner-occupied commercial real estate loans, which are generally less dependent upon income generated directly from the property, but still carry risks from the successful operation of the underlying business or adverse economic conditions. Additionally, as of December 31, 2021, the Company’s nonresidential real estate loans included $479.3 million of non-owner-occupied commercial real estate loans, which generally involve relatively large balances to single borrowers or related groups of borrowers. Nonresidential real estate loans expose a lender to greater credit risk because the collateral securing these loans is typically more difficult to liquidate due to fluctuations of the value of the collateral.

As of December 31, 2021, $460.7 million, or 16.0%, of the Company’s loans were construction and development loans, which typically are secured by a project under construction. It can be difficult to accurately evaluate the total funds required to complete a project and construction and development lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If the Company is forced to foreclose on a project prior to completion, it may be unable to recover the entire unpaid portion of the loan. In addition, the Company may be required to fund additional amounts to complete a project, incur taxes, maintenance and compliance costs for a foreclosed property and may have to hold the property for an indeterminate period.

In considering whether to make a loan secured by real property, the Company generally requires an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time of appraisal. These estimates may not accurately describe the value of the real property collateral and the Company may not be able to realize the full amount of any remaining indebtedness when it forecloses on and sells the relevant property.

If the Company forecloses on a loan with real estate assets as collateral, it will own the underlying real estate, subjecting it to the costs and potential risks associated with the ownership. The amount that may be realized after a default is dependent upon factors outside of the Company’s control, including, but not limited to, general or local economic conditions, environmental cleanup liability, assessments, real estate tax rates, operating expenses of the mortgaged properties, ability to obtain and maintain adequate occupancy of the properties, zoning laws, governmental and regulatory rules and natural disasters.

The Company is subject to risks arising from loans in its loan portfolio collateralized by general business assets.

As of December 31, 2021, commercial and industrial loans were $634.4 million, or 22.0%, of the Company’s gross loans. Commercial and industrial loans are generally collateralized by general business assets, including, among other things, accounts receivable, inventory and equipment and most are backed by a personal guaranty of the borrower or principal. Commercial and industrial loans are typically larger in amount than loans to individuals and, therefore, have the potential for larger losses on a single loan basis and repayment is subject to the ongoing business operations risks of the borrower. The collateral securing such loans generally includes moveable property such as equipment and inventory, which may decline in value more rapidly than the Company anticipates, thus exposing it to increased credit risk.

Table

The Company’s largest loan and deposit relationships currently make up significant percentages of the loan portfolio and deposits.

As of December 31, 2021, the Company’s 15 largest loan relationships, including related entities, totaled $346.8 million, or 12.1%, of its gross loans. The concentration risk associated with having a small number of large loan relationships is that, if one or more of these relationships were to become delinquent or suffer default, the Company could be at serious risk of material losses. The ACL may not be adequate to cover losses associated with any of these relationships and any loss or increase in the allowance would negatively impact the Company’s earnings and capital. Even if the loans are collateralized, a large increase in classified assets could harm the Company’s reputation with regulators and inhibit its ability to execute its business plan.

As of December 31, 2021, the Company’s 15 largest depositors, including related entities, totaled $656.4 million, or 17.1%, of total deposits. Several of the Company’s large depositors have business, family, or other relationships with each other, which creates a risk that any one customer’s withdrawal of their deposits could lead to a loss of other deposits from customers within the relationship. Withdrawals of deposits by any one of the Company’s largest depositors or by the related customer groups could force the Company to rely more heavily on borrowings and other sources of funding for its business and withdrawal demands, which may be more expensive and less stable.

The Company could be adversely impacted by the unexpected loss of the services of its executive management team and other key employees.

The Company’s success depends in large part on the performance of its executive management team and other key personnel, as well as on its ability to attract, motivate and retain highly qualified senior and middle management and other skilled employees. Competition for qualified employees is intense and the process of locating qualified key personnel may be lengthy and expensive. If any of the executive management team contract COVID-19, the Company may lose their services for an extended period of time, which would likely have a negative impact on its business and operations.

A significant percentage of the Company’s key employees and executive leaders live and work in Houston and Beaumont, Texas. This concentration of its personnel, technology, and facilities increases the Company’s risk of business disruptions if the COVID-19 pandemic (or a significant outbreak of another contagious disease) impacts the Houston, Beaumont or Dallas metropolitan areas negatively. Some of the Company’s employees and management contracted COVID-19. If the Company continues to experience cases of COVID-19 among the employees or such cases become widespread at the Company, it will place more pressure on the remaining employees to perform all functions across the organization while maintaining their health. Although certain remedial measures have been taken, including quarantine, temporary branch closure, remote working, and shift working, increased COVID-19 diagnoses may require the Company to take additional remediation measures and could impair its ability to conduct business. The Company may not be successful in retaining its key employees or finding adequate replacements for lost personnel.

The Company is subject to interest rate risk.

Changes in interest rates could have an adverse impact on the Company’s net interest income, business, financial condition and results of operations. Many factors outside the Company’s control impact interest rates, including governmental monetary policies and macroeconomic conditions. A majority of banking assets and liabilities are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, the Company’s earnings are significantly dependent on its net interest income and are subject to “gaps” in the interest rate sensitivities of assets and liabilities that may negatively impact earnings. Interest rate increases often result in larger payment requirements for borrowers, which increase the potential for default and delayed payment, and reduces demand for collateral securing the loan. Further, loans in nonaccrual status require continued funding costs, but result in decreased interest income. Interest rate increases may also reduce the demand for loans and increase competition for deposits. Declining interest rates can increase loan prepayments and long-term fixed rate credits, which could adversely impact earnings and net interest margin if rates increase. If short-term interest rates remain at low levels for a prolonged period and longer-term interest rates fall, the Company could experience net interest margin compression as interest-earning assets would continue to reprice downward while interest-bearing liability rates could fail to decline in tandem. Changes in interest rates can also impact the value of loans, securities and other assets.

Table

The Company is subject to liquidity risk.

Liquidity risk is the potential that the Company will be unable to meet its obligations as they become due because of an inability to liquidate assets or obtain adequate funding. The Company requires sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on debt obligations as they come due and other cash commitments under both normal operating conditions and unpredictable circumstances, including events causing industry or general financial market stress. The Company relies on its ability to generate deposits and effectively manage the repayment and maturity schedules of loans and securities to ensure that it has adequate liquidity to fund operations. An inability to raise funds through deposits, borrowings, loan repayments, sales of the Company’s securities, sales of loans and other sources could have a negative impact liquidity.

The Company’s most important source of funds is deposits, which have historically been stable sources of funds. However, deposits are subject to potentially dramatic fluctuations in availability or price due to factors that may be outside of the Company’s control, including increasing competitive pressure from other financial services firms for consumer or corporate customer deposits, changes in interest rates and returns on other investment classes. As a result, there could be significant outflows of deposits within short periods of time or significant changes in pricing necessary to maintain current customer deposits or attract additional deposits, increasing funding costs and reducing net interest income and net income.

The Company has unfunded commitments to extend credit, which are formal agreements to lend funds to customers as long as there are no violations of any conditions established in the contracts. Unfunded credit commitments are not reflected on the Company’s consolidated balance sheet and are generally not drawn upon. Borrowing needs of customers may exceed the Company’s expectations, especially during a challenging economic environment where clients are more dependent on credit commitments. Increased borrowings under these commitments could adversely impact liquidity.

The Company’s access to funding sources, such as through its line of credit, capital markets offerings, borrowing from the Federal Reserve Bank of Dallas and the FHLB Dallas, or from other third-parties, in amounts adequate to finance or capitalize its activities, or on terms that are acceptable, could be impaired by factors that affect the Company directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry.

The Company is dependent on the use of data and modeling in its decision-making.

The use of statistical and quantitative models and other quantitative analyses is endemic to bank decision-making and the employment of such analyses is becoming increasingly widespread in the Company’s operations. Liquidity stress testing, interest rate sensitivity analysis and the identification of possible violations of AML regulations are all examples of areas which are dependent on models and the data that underlies them. The use of statistical and quantitative models is also becoming more prevalent in regulatory compliance. While the Company is not currently subject to annual Dodd-Frank Act stress testing and Comprehensive Capital Analysis and Review submissions, it anticipates that model-derived testing may become more extensively implemented by regulators in the future.

The Company anticipates data-based modeling will penetrate further into bank decision-making, particularly risk management efforts, as the capacities developed to meet rigorous stress testing requirements can be employed more widely and in differing applications. While the Company believes these quantitative techniques and approaches improve decision-making, they also create the possibility that faulty data or flawed quantitative approaches could negatively impact its decision-making ability or if the Company became subject to regulatory stress testing in the future, adverse regulatory scrutiny. Further, because of the complexity inherent in these approaches, misunderstanding or misuse of their outputs could similarly result in suboptimal decision-making.

Table

The Company’s accounting estimates rely on analytical and forecasting models.

The processes the Company uses to estimate its ACL, assess the value of financial instruments, goodwill and other intangibles for potential credit losses or impairment depend upon the use of analytical and forecasting models, judgments, assumptions and estimates that impact the amounts reported in the Company’s consolidated financial statements and accompanying notes. The accounting policies the Company considers to be the most significant accounting policies and methods requiring judgments, assumptions and estimates are discussed further in “Part II.—Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies.”  

The Company’s goodwill, other intangibles and other long-lived assets may become impaired.

The Company reviews goodwill, other intangibles and other long-lived assets for impairment at least annually, or more frequently if a triggering event occurs which indicates that the carrying value of these assets might be impaired. While the Company has not recorded any impairment charges related to these assets, future evaluations may result in findings of impairment and related write-downs.

Potential credit losses on securities held in the Company’s portfolio.

The Company invests in securities with the primary objectives of providing a source of liquidity, providing an appropriate return on funds invested, managing interest rate risk, meeting pledge requirements and meeting regulatory capital requirements. Factors beyond the Company’s control can significantly and adversely influence the fair value of securities in its portfolio. For example, fixed rate securities are generally subject to decreases in market value when interest rates rise. Additional factors include, but are not limited to, rating agency downgrades of the securities or issuers, defaults by the issuer or individual borrowers with respect to the underlying securities and instability in the credit markets. Any of the foregoing factors could cause an expected credit loss which would require the Company to record an ACL and related provision which would impact earnings. The process for determining whether securities are impaired requiring an ACL usually requires subjective judgments about the future financial performance of the issuer and any collateral underlying the security to assess the probability of receiving all contractual principal and interest payments on the security. Although the Company has not recorded an ACL related to its securities portfolio as of December 31, 2021, changing economic and market conditions affecting interest rates, the financial condition of issuers of the securities and the performance of the underlying collateral, among other factors, may cause it to record an ACL in future periods.

The Company is subject to risk arising from failure to maintain internal control over financial reporting.

Management is responsible for establishing and maintaining adequate internal control over financial reporting and for evaluating and reporting on that system of internal control. In the past, significant deficiencies have been identified in the Company’s internal controls over financial reporting. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of financial reporting. The Company’s actions to maintain effective controls and remedy any weakness or deficiency may not be sufficient to result in an effective internal control environment and any future failure to maintain effective internal control over financial reporting could impair the reliability of its financial statements, which in turn could harm its business, impair investor confidence in the accuracy and completeness of its financial reports, impair access to the capital markets, cause the price of the Company’s common stock to decline and subject it to increased regulatory scrutiny and/or penalties, and higher risk of shareholder litigation.

Changes in accounting standards could materially impact the Company’s financial statements.

From time to time the FASB or the SEC change the financial accounting and reporting standards that govern the preparation of the Company’s financial statements. Such changes may result in the Company’s financial statements being subject to new accounting and reporting standards or change existing accounting and reporting standards. In addition, the bodies that interpret the accounting standards (such as banking regulators or outside auditors) may change their interpretations or positions on how new or existing standards should be applied. These changes may be beyond the Company’s control, can be hard to predict and can materially impact how it records and reports the Company’s financial condition and results of operations. In some cases, the Company may be required to apply a new standard, a revision to an existing standard or change the application of a standard in such a way that financial statements for periods previously reported are revised.

Table

Potential repurchases and indemnity requests for loans sold to correspondent banks.

The Company originates residential mortgage loans for sale to correspondent banks who may resell such mortgages to government-sponsored enterprises, such as Federal National Mortgage Loan Association, or Fannie Mae, Federal Home Loan Mortgage Corporate, or Freddie Mac, and other investors. As a part of this process, the Company makes various representations and warranties to the purchasers that are tied to the underwriting standards under which the investors agreed to purchase the loan. If a representation or warranty proves to be untrue, the Company could be required to repurchase one or more of the mortgage loans or indemnify the investor. Repurchase and indemnity obligations tend to increase during weak economic times, as investors seek to pass on the risks associated with mortgage loan delinquencies to the originator of the mortgage. Although the Company did not repurchase any residential mortgage loans sold to correspondent banks in 2021, if it is forced to repurchase mortgage loans in the future that it previously sold to investors, or indemnify those investors, the Company’s business, financial condition and results of operations could be adversely impacted.

The Company’s growth strategy, which includes acquisitions and de novo branching, includes a number of risks.

The Company intends to pursue acquisition opportunities that it believes complement its activities and may enhance profitability and provide attractive risk-adjusted returns. The Company’s acquisition activities could be material to its business and involve a number of risks, including, but not limited to, the following:

The Company’s business strategy includes evaluating strategic opportunities to grow through de novo branching which carries with it certain potential risks, including: significant startup costs and anticipated initial operating losses; an inability to gain regulatory approval; an inability to secure the services of qualified senior management to operate the de novo banking locations; and difficulties successfully integrating and promoting the Company’s corporate culture among other challenges. Failure to adequately manage the risks associated with the Company’s growth through de novo branching could have a material adverse impact on its business, financial condition and results of operations.

​

Table

Risks Related to the Economy and the Company’s Industry

The Company could be adversely impacted by natural disasters, pandemics and other catastrophes.

The Company operates banking locations throughout the Houston and Beaumont areas, which are susceptible to hurricanes, tropical storms, other adverse weather conditions, pandemics and other catastrophes. In addition, man-made events such as acts of terror, governmental responses to acts of terror, malfunctions of the electronic grid and other infrastructure breakdowns (such as the grid failures in February 2021 resulting from unusually cold weather for the region) could adversely affect economic conditions in its markets. These adverse weather and catastrophic events can disrupt operations, cause widespread and extensive property damage, force the relocation of residents and significantly disrupt economic activity in the region, significantly depress the local economies in which the Company operates and adversely affect its customers. If the economies in the Company’s markets experience an overall decline because of a catastrophic event, demand for loans and its other products and services could decline. In addition, the rates of delinquencies, foreclosures, bankruptcies and losses on the Company’s loan portfolios may increase substantially after events such as hurricanes, as uninsured property losses, interruptions of its customers’ operations or sustained job interruption or loss may materially impair the ability of borrowers to repay their loans. Moreover, the value of real estate or other collateral that secures the Company’s loans could be materially and adversely affected by a catastrophic event.

The Company be adversely impacted by sustained volatility in oil prices and downturns in the energy industry.

The economy in Texas is dependent on the energy industry. Volatile oil prices, instability in the industry and the resulting downturns or lack of growth in the energy industry and energy-related business could have a negative impact on the Texas economy and adversely impact the Company’s results of operations and financial condition. The oil and gas industry experienced a sustained downturn due to low oil and gas prices. Although oil prices increased in 2022, the oil and gas industry has remained unstable and prolonged instability may cause further worsening conditions of energy companies, oilfield services companies, related businesses and overall economic activities in the Company’s primary markets and could lead to increased credit stress in its loan portfolio, increased losses and weaker demand for lending. More significantly for the Company, low oil prices or general uncertainty resulting from energy price volatility could have other adverse impacts such as significant job losses in industries tied to energy, lower spending habits, lower borrowing needs, negative impact on construction and real estate related to energy and a number of other potential impacts that are difficult to isolate or quantify. The oil and gas industry may not recover meaningfully in the near term.

The Company operates in a highly competitive industry and market area.

The Company operates in the highly competitive financial services industry and face significant competition for customers from financial institutions located both within and beyond the Company’s principal markets. The Company competes with commercial banks, savings banks, credit unions, nonbank financial services companies and other financial institutions operating within or near the areas it serves. Certain large banks headquartered outside of the Company’s markets and large community banking institutions target the same customers it does. Technology has lowered barriers to entry and made it possible for banks to expand their geographic reach by providing services over the internet and mobile devices and for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. The banking industry has experienced rapid changes in technology and, as a result, the Company’s future success may depend in part on its ability to address customer needs by using technology. Customer loyalty can be influenced by a competitor’s new products, especially offerings that could provide cost savings or a higher return to the customer. Increased lending activity of competing banks can also lead to increased competitive pressures on loan rates and terms for high-quality credits. The Company may not be able to compete successfully with other financial institutions in its markets and it may have to pay higher interest rates to attract deposits, accept lower yields to attract loans and pay higher wages for new employees, resulting in lower net interest margins and reduced profitability.

Many of the Company’s nonbank competitors are not subject to the same extensive regulations that govern its activities and may have greater flexibility in competing for business. The financial services industry could become even more competitive because of legislative, regulatory and technological changes and continued consolidation. In addition, some of the Company’s current commercial banking customers may seek alternative banking sources as they develop needs for credit facilities larger than the Company may be able to accommodate.

Table

The Company could be adversely impacted by the soundness of other financial institutions.

Financial services institutions are interrelated because of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional clients. Many of these transactions expose the Company to credit risk in the event of a default by a counterparty or client. In addition, credit risk may be exacerbated when collateral cannot be foreclosed upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due.

Risks Related to Cybersecurity, Third-Parties and Technology

The Company depends on information technology and telecommunications systems, including third-party service providers.

The Company’s business depends on the successful and uninterrupted functioning of its information technology and telecommunications systems including with third-party servicers and financial intermediaries. The Company relies on third-parties for certain services, including, but not limited to, core systems processing, website hosting, internet services, monitoring its network and other processing services. The Company’s business depends on the successful and uninterrupted functioning of information technology and telecommunications systems and third-party service providers. The failure of these systems, an information security or cybersecurity breach involving any of the Company’s third-party service providers, or the termination or change in terms of a third-party software license or service agreement on which any of these systems is based, could adversely impact the Company’s business, financial condition and results of operations.

In addition, the Company’s primary federal regulator, the OCC, has issued guidance outlining the expectations for third-party service provider oversight and monitoring by financial institutions. Any failure on the Company’s part to adequately oversee the actions of its third-party service providers could result in regulatory actions against the Bank.

The Company could be adversely impacted by fraudulent activity, breaches of its information security and cybersecurity attacks.

As a financial institution, the Company is susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against it, its clients, or third-parties with whom the Company interacts and that may result in financial losses or increased costs to it or its clients, disclosure or misuse of confidential information belonging to the Company or personal or confidential information belonging to its clients, misappropriation of assets, litigation, or damage to the Company’s reputation. The Company’s industry has seen increases in electronic fraudulent activity, hacking, security breaches, sophisticated social engineering and cyber-attacks, including within the commercial banking sector, as cyber-criminals have been targeting commercial bank and brokerage accounts on an increasing basis.

The Company’s business is highly dependent on the security and efficacy of its infrastructure, computer and data management systems, as well as those of third-parties with whom it interacts or on whom it relies. The Company’s business relies on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in its computer and data management systems and networks and in the computer and data management systems and networks of third-parties. In addition, to access the Company’s network, products and services, its customers and other third-parties may use personal mobile devices or computing devices that are outside of the Company’s network environment and are subject to their own cybersecurity risks. All of these factors increase the Company’s risks related to cyber-threats and electronic disruptions.

In addition to well-known risks related to fraudulent activity, which take many forms, such as check “kiting” or fraud, wire fraud, and other dishonest acts, information security breaches and cybersecurity-related incidents have become a material risk to the Company and in the financial services industry in general. These threats may include fraudulent or unauthorized access to data processing or data storage systems used by the Company or by its clients, electronic identity theft, “phishing”, account takeover, denial or degradation of service attacks, and malware or other cyber-attacks. These electronic viruses or malicious code are typically designed to, among other things, obtain unauthorized access to

Table

confidential information belonging to the Company or its clients and customers; manipulate or destroy data; disrupt, sabotage or degrade service on a financial institution’s systems; or steal money.

Unfortunately, it is not always possible to anticipate, detect or recognize these threats to the Company’s systems, or to implement effective preventative measures against all breaches, whether those breaches are malicious or accidental. Cybersecurity risks for banking organizations have significantly increased in recent years and have been difficult to detect before they occur because of the following, among other reasons:

While the Company invests in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and it conducts periodic tests of its security systems and processes, the Company may not succeed in anticipating or adequately protecting against or preventing all security breaches and cyber-attacks from occurring. Even the most advanced internal control environment may be vulnerable to compromise. As cyber-threats continue to evolve, the Company may be required to expend significant additional resources to continue to modify or enhance its protective measures or to investigate and remediate any information security vulnerabilities or incidents.

As is the case with non-electronic fraudulent activity, cyber-attacks or other information or security breaches, whether directed at the Company or third-parties, may result in a material loss or have material consequences. Furthermore, the public perception that a cyber-attack on the Company’s systems has been successful, whether or not this perception is correct, may damage its reputation with customers and third-parties with whom it does business. A successful penetration or circumvention of system security could expose the Company to additional regulatory scrutiny and result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in the Company’s security measures, reputational damage, reimbursement or other compensatory costs, additional compliance costs, and could adversely impact its results of operations, liquidity and financial condition.

During 2018, the Company experienced a security incident involving the possible unauthorized access of certain personal information in the possession of the Bank. The Company takes the privacy of personal information seriously and took steps to address the incident promptly after it was discovered, including initiating an internal investigation into the incident and working with an independent forensic investigation firm to assist in the investigation of and response to the incident. The Company also reported the incident to law enforcement authorities. Based on the report of the independent forensic investigation firm, the Company believes that a phishing incident occurred where certain emails and attachments from two employee email accounts may have been accessed by an unauthorized person. The Company believes that these email accounts contained certain personal information for approximately 7,800 individuals. Although the Company’s investigation did not find any evidence that the incident involved any unauthorized access to or use of any of the Bank’s internal computer systems or network, and it believes that the access was limited to information that was contained in the email accounts of the two employees, the Company may become subject to claims in the future for purportedly fraudulent transactions or other matters arising out of the breach of information stored in the affected email accounts. Additionally, the incident may have a negative impact on the Company’s reputation if it becomes subject to claims in the future, and

Table

reputational harm arising out of such claims or litigation may cause its customers to lose confidence in the Company’s ability to safeguard their information.

​

Table

Risks Related to Legal, Reputational and Compliance Matters

The Company is subject to laws regarding the privacy, information security and protection of personal information.

The Company’s business requires the collection and retention of large volumes of customer data, including personally identifiable information in various information systems that it maintains and in those maintained by third-parties with whom the Company contracts to provide data services. The Company also maintains important internal company data such as personally identifiable information about its employees and information relating to its operations. The Company is subject to complex and evolving laws and regulations governing the privacy and protection of personal information of individuals (including customers, employees, suppliers and other third-parties). For example, the Company’s business is subject to the GLB Act which, among other things: (i) imposes certain limitations on its ability to share nonpublic personal information about customers with nonaffiliated third-parties; (ii) requires it  provide certain disclosures to customers about information collection, sharing and security practices and afford customers the right to “opt out” of any information sharing by the Company with nonaffiliated third-parties (with certain exceptions); and (iii) requires that it develops, implements and maintains a written comprehensive information security program containing appropriate safeguards based on its size and complexity, the nature and scope of the Company’s activities and the sensitivity of customer information it processes, as well as plans for responding to data security breaches. There are various state and federal data security breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach. Ensuring that the Company’s collection, use, transfer and storage of personal information complies with all applicable laws and regulations can increase its costs.

Furthermore, the Company may not be able to ensure that all of its clients, suppliers, counterparties and other third-parties have appropriate controls in place to protect the confidentiality of the information that they exchange with it, particularly where such information is transmitted by electronic means. If personal, confidential or proprietary information of customers or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information, or where such information was intercepted or otherwise compromised by third-parties), the Company could be exposed to litigation or regulatory sanctions under personal information laws and regulations. Concerns regarding the effectiveness of the Company’s measures to safeguard personal information, or even the perception that such measures are inadequate, could cause it to lose customers or potential customers for its products and services and thereby reduce its revenues. Accordingly, any failure or perceived failure to comply with applicable privacy or data protection laws and regulations may subject the Company to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or in significant liabilities, fines or penalties and could damage the Company’s reputation and otherwise adversely impact its operations and financial condition.

The Company could be adversely impacted by employee errors and customer or employee fraud.

As a financial institution, employee errors and employee or customer misconduct could cause financial losses or regulatory sanctions and seriously harm the Company’s reputation. Misconduct by employees could include hiding unauthorized activities, improper or unauthorized activities on behalf of customers or improper use of confidential information, each of which can be damaging to the Company. It is not always possible to prevent employee errors and misconduct and the precautions taken to prevent and detect this activity may not be effective in all cases. Employee errors could also subject the Company to financial claims for negligence.

The Company maintains a system of internal controls to mitigate operational risks, including data processing system failures and errors and customer or employee fraud, as well as insurance coverage designed to protect it from material losses associated with these risks, including losses resulting from any associated business interruption. If these internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could adversely impact the Company’s business, financial condition and results of operations.

The Company depends on the accuracy and completeness of information provided by its borrowers and counterparties.

In deciding whether to approve loans or to enter into other transactions with borrowers and counterparties, the Company relies on information furnished by, or on behalf of, borrowers and counterparties, including financial statements, credit reports, audit reports, other financial information and representations as to accuracy and completeness of that information. Any intentional or negligent misrepresentation, if undetected prior to loan funding, may significantly lower the value of the loan, and the Company may be subject to regulatory action. The Company generally bears the risk of loss

Table

associated with these misrepresentations. The Company’s controls and processes may not detect misrepresented information. Any such misrepresented information could adversely impact the Company’s business, financial condition and results of operations.

The Company may be subject to environmental liabilities in connection with the real properties it owns and the foreclosure on real estate assets securing the loan portfolio.

The Company may purchase real estate in connection with its acquisition and expansion efforts, or it may foreclose on and take title to real estate or otherwise be deemed to be in control of property that serves as collateral on loans. The Company could be subject to environmental investigation, remediation, or liabilities with respect to those properties. The costs associated with investigation or remediation activities or based on third-party common law claims could be substantial and may substantially exceed the value of the affected properties or the loans secured by those properties. The Company may not have adequate remedies against the prior owners or other responsible parties and may not be able to resell the affected properties either before or after completion of any removal or abatement procedures.

The Company is subject to claims and litigation pertaining to intellectual property in addition to other litigation in the ordinary course of business.

Banking and other financial services companies, such as the Company, rely on technology companies to provide information technology products and services necessary to support their day-to-day operations. Technology companies frequently enter litigation based on allegations of patent infringement or other violations of intellectual property rights. The Company also uses trademarks and logos for marketing purposes, and third-parties may allege that the Company’s marketing, processes or systems may infringe their intellectual property rights. Competitors of the Company’s vendors, or other individuals or companies, may from time to time claim to hold intellectual property sold to the Company. Such claims may increase in the future as the financial services sector becomes more reliant on information technology vendors. The plaintiffs in these actions frequently seek injunctions and substantial damages. Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, the Company may have to engage in protracted litigation that can be expensive, time-consuming, and disruptive to operations and distracting to management.

In addition to litigation relating to intellectual property, the Company is regularly involved in litigation matters in the ordinary course of business. While the Company believes that these litigation matters should not have a material adverse impact on its business, financial condition, results of operations or future prospects, it may be unable to successfully defend or resolve any current or future litigation matters.

Negative public opinion regarding the Company or its failure to maintain the Company’s or the Bank’s reputation in the communities served could adversely impact business.

As a community bank, the Company’s reputation within the communities served is critical to its success. The Company believes it has set itself apart from competitors by building strong personal and professional relationships with its customers and by being an active member of the communities it serves. The Company strives to enhance its reputation by recruiting, hiring and retaining employees who share the Company’s core values of being an integral part of the communities it serves and delivering superior service to customers. Negative public opinion could result from the Company’s actual or alleged conduct in any number of activities, including (i) lending practices, (ii) expansion strategy, (iii) product and service offerings, (iv) corporate governance, (v) regulatory compliance, (vi) mergers and acquisitions, (vii) disclosure, (viii) sharing or inadequate protection of customer information, (ix) successful or attempted cyber-attacks against the Company, its customers or its third-party partners or vendors and (x) failure to discharge any publicly announced commitments to employees or environmental, social and governance initiatives or to respond adequately to social and sustainability concerns from the viewpoint of its stakeholders from actions taken by government regulators and community organizations in response to the Company’s conduct. If the Company’s reputation is negatively affected by the actions of its employees or otherwise, the Company may be less successful in attracting new talent and customers or may lose existing customers. Further, negative public opinion can expose the Company to litigation and regulatory action and could delay and impede efforts to implement its expansion strategy.

Table

Risks Related to the Regulation of the Company’s Industry

The Company operates in a highly regulated environment.

The Company is subject to extensive regulation, supervision and legal requirements that govern almost all aspects of its operations. These laws and regulations are not intended to protect the Company’s shareholders, but rather, they are intended to protect customers, depositors, the Deposit Insurance Fund and the overall financial stability of the U.S. Compliance with laws and regulations can be difficult and costly and changes to laws and regulations often impose additional operating costs. Failure to comply with these laws and regulations could subject the Company to restrictions on business activities, enforcement actions and fines and other penalties, any of which could adversely affect the Company’s results of operations, regulatory capital levels and the price of its securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely impact the Company’s business, financial condition and results of operations. See “Part I.—Item 1.—Business—Supervision and Regulation.”

The Company could be adversely impacted if it fails to comply with any supervisory actions.

As part of the bank regulatory process, the OCC and the Federal Reserve periodically conduct examinations of the Company’s business, including compliance with laws and regulations. If one of these federal banking agencies were to determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, asset sensitivity, risk management or other aspects of any of the Company’s operations have become unsatisfactory, or that the Company, the Bank or their respective management were in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital levels, to restrict growth, to assess civil monetary penalties against the Company, the Bank or their respective officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate the Bank’s deposit insurance. Becoming subject to such regulatory actions could adversely impact the Company’s reputation, business, financial condition and results of operations.

Many of the Company’s new activities and expansion plans require regulatory approvals and failure to obtain them may restrict growth.

The Company intends to complement and expand its business by pursuing strategic acquisitions of financial institutions and other complementary businesses and de novo branching. Generally, the Company must receive federal regulatory approval before it can acquire a depository institution or related business insured by the FDIC, or before it can open a new branch. Such regulatory approvals may not be granted on acceptable terms or at all. The Company may also be required to sell banking locations as a condition to receiving regulatory approval, which may not be acceptable or may reduce the benefit of any acquisition.

The Company faces a risk of noncompliance and enforcement action related to AML statutes and regulations.

The BSA, the USA PATRIOT Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective AML program and file suspicious activity and currency transaction reports as appropriate. FinCEN, established by the U.S. Department of the Treasury to administer the BSA, is authorized to impose significant civil money penalties for violations of those requirements and frequently coordinates enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, the Drug Enforcement Administration and the IRS. There is also increased scrutiny of compliance with the sanctions programs and rules administered and enforced by OFAC. To comply with regulations, guidelines and examination procedures in this area, the Company has dedicated significant resources to its AML program. If the Company’s policies, procedures, systems and practices are deemed deficient, it could be subject to liability, including fines, regulatory actions such as restrictions on its ability to pay dividends and the inability to obtain regulatory approvals to proceed with certain aspects of its business plans, including acquisitions and de novo branching, and criminal sanctions.

Table

The Company is subject to numerous laws designed to protect consumers and failure to comply with these laws could lead to a wide variety of sanctions.

The CRA, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The CFPB, the U.S. Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. The CFPB was created under the Dodd-Frank Act to centralize responsibility for consumer financial protection with broad rulemaking authority to administer and carry out the purposes and objectives of federal consumer financial laws with respect to all financial institutions that offer financial products and services to consumers. The CFPB is also authorized to prescribe rules applicable to any covered person or service provider, identifying and prohibiting acts or practices that are “unfair, deceptive, or abusive” in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. The ongoing broad rulemaking powers of the CFPB have potential to have a significant impact on the operations of financial institutions offering consumer financial products or services. The CFPB has indicated that it may propose new rules on overdrafts and other consumer financial products or services, which could have a material adverse impact on the Company’s business, financial condition and results of operations if any such rules limit the Company’s ability to provide such financial products or services.

A successful regulatory challenge to the Company’s performance under the CRA, fair lending laws or regulations, or consumer lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion and restrictions on entering new business lines. Private parties can also challenge the Bank’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse impact on the Company’s business, financial condition and results of operations.

Failure to comply with economic and trade sanctions or with applicable anti-corruption laws could have a material adverse impact on the Company’s business, financial condition and results of operations.

OFAC administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws, including designated foreign countries, nationals and others. The Company is responsible for, among other things, blocking accounts of and transactions with such persons and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. The Company is subject to the Foreign Corrupt Practices Act, or the FCPA through the Bank and the Company’s agents and employees, which prohibits offering, promising, giving, or authorizing others to give anything of value, either directly or indirectly, to a non-U.S. government official in order to influence official action or otherwise gain an unfair business advantage. The Company is also subject to applicable anti-corruption laws in the jurisdictions in which it may operate. The Company has implemented policies, procedures and internal controls that are designed to comply with economic and trade sanctions or with applicable anti-corruption laws, including the FCPA. Failure to comply with economic and trade sanctions or with applicable anti-corruption laws, including the FCPA, could have serious legal and reputational consequences for the Company.

Federal, state and local consumer lending laws may restrict the Company’s ability to originate certain mortgage loans or increase the risk of liability with respect to such loans.

Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. It is the Company’s policy not to make predatory loans, but these laws create the potential for liability with respect to the Company’s lending and loan investment activities. They increase the Company’s cost of doing business and, ultimately, may prevent it from making certain loans and cause it to reduce the average percentage rate or the points and fees on loans that the Company makes.

Federal, state and local regulations and/or the licensing of loan servicing, collections and the Company’s sales of loans to third-parties may increase the cost of compliance and the risks of noncompliance and subject it to litigation.

The Company services some of its loans and loan servicing is subject to extensive regulation by federal, state and local governmental authorities, as well as various laws and judicial and administrative decisions imposing requirements

Table

and restrictions on those activities. The volume of new or modified laws and regulations has increased in recent years and, in addition, some individual municipalities have begun to enact laws that restrict loan servicing activities, including delaying or temporarily preventing foreclosures or forcing the modification of certain mortgages. If regulators impose new or more restrictive requirements, the Company may incur additional significant costs to comply with such requirements, which may further adversely affect it. In addition, if the Company were subject to regulatory investigation or regulatory action regarding its loan modification and foreclosure practices, the Company’s financial condition and results of operations could be adversely impacted.

In addition, the Company sells loans to third-parties and as part of these sales, the Company makes various representations and warranties. Breaches of these representations and warranties may result in a requirement that the Company repurchases the loans, or otherwise make whole or provide other remedies to counterparties. These aspects of the Company’s business or its failure to comply with applicable laws and regulations could possibly lead to civil and criminal liability, loss of licensure, damage the Company’s reputation in the industry, fines, penalties and litigation, including class action lawsuits and administrative enforcement actions.

Potential limitations on incentive compensation contained in proposed federal agency rulemaking may adversely impact the Company’s ability to attract and retain its highest performing employees.

In April 2011 and May 2016, the Federal Reserve, other federal banking agencies and the SEC jointly published proposed rules designed to implement provisions of the Dodd-Frank Act prohibiting incentive compensation arrangements that would encourage inappropriate risk taking at covered financial institutions, which includes a bank or bank holding company with $1 billion or more in assets, such as the Bank. It cannot be determined at this time whether or when a final rule will be adopted and whether compliance with such a final rule will substantially affect the way the Company structures compensation for its executives and other employees. Depending on the nature and application of the final rules, the Company may not be able to successfully compete with certain financial institutions and other companies that are not subject to some or all the rules to retain and attract executives and other high performing employees. If this were to occur, relationships that the Company has established with its clients may be impaired and the Company’s business, financial condition and results of operations could be adversely impacted.

Increases in FDIC insurance premiums could adversely impact earnings and results of operations.

The Bank is generally unable to control the amount of premiums that it is required to pay for FDIC insurance. In 2010, the FDIC increased the Deposit Insurance Fund’s target reserve ratio to 2.0% of insured deposits following the Dodd-Frank Act’s elimination of the 1.5% cap on the Deposit Insurance Fund’s reserve ratio and the FDIC is required to put in place a restoration plan should the Deposit Insurance Fund fall below its 1.35% minimum reserve ratio. If the Deposit Insurance Fund falls below its minimum reserve ratio or fails to meet its funding requirements, special assessments or increases in deposit insurance premiums may be required. Further, if there are additional financial institution failures that affect the Deposit Insurance Fund, the Bank may be required to pay higher FDIC premiums.

The Federal Reserve may require the Company to commit capital resources to support the Bank.

The Federal Reserve requires a bank holding company to act as a source of financial and managerial strength to its subsidiary banks and to commit resources to support its subsidiary banks. Under the “source of strength” doctrine that was codified by the Dodd-Frank Act, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank at times when the bank holding company may not be inclined to do so and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. Accordingly, the Company could be required to provide financial assistance to the Bank if it experiences financial distress.

A capital injection may be required at a time when resources are limited and the Company may be required to borrow the funds or raise capital to make the required capital injection. Any loan by a bank holding company to its subsidiary bank is subordinate in right with payment to deposits and certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the holding company’s general unsecured creditors, including the holders of any note obligations. Thus, any borrowing by a bank

Table

holding company to make a capital injection to a subsidiary bank often becomes more difficult and expensive relative to other corporate borrowings.

The Company could be adversely impacted by monetary policies and regulations of the Federal Reserve.

In addition to being affected by general economic conditions, the Company’s earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the U.S. money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market purchases and sales of securities, adjustments of both the discount rate and the federal funds rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits. The monetary policies and regulations of the Federal Reserve have had a significant impact on the operating results of commercial banks in the past and are expected to continue to do so in the future. Although the Company cannot determine the effects of such policies on it, such policies could adversely impact the Company’s business, financial condition and results of operations.

The Company is subject to commercial real estate lending guidance issued by the federal banking regulators that impacts its operations and capital requirements.

The OCC and the other federal bank regulatory agencies have promulgated joint guidance on sound risk management practices for financial institutions regarding concentrations in commercial real estate lending. See “Item 1. Business—Supervision and Regulation—Concentrated Commercial Real Estate Lending Obligations.” Under the guidance, a financial institution that, like the Bank is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations.

The focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance provides that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. While the Company believes it has implemented policies and procedures with respect to its commercial real estate loan portfolio consistent with this guidance, bank regulators could require the Company to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to the Company or that may result in a curtailment of its commercial real estate lending and/or the requirement that the Bank maintains higher levels of regulatory capital, either of which would adversely impact the Company’s loan originations and profitability.

The Company has made loans to and accepted deposits from related parties.

From time to time, the Bank has made loans to and accepted deposits from certain of the Company’s directors and officers and the directors and officers of the Bank in compliance with applicable regulations and the Company’s written policies. The Company’s business relationships with related parties are highly regulated. In particular, the Company’s ability to do business with related parties is limited with respect to, among other things, extensions of credit described in the Federal Reserve’s Regulation O and covered transactions described in sections 23A and 23B of the Federal Reserve Act and the Federal Reserve’s Regulation W. If the Company fails to comply with any of these regulations, it could be subject to enforcement and other legal actions by the Federal Reserve.

Risks Related to Ownership of the Company’s Common Stock

The market price of the Company’s common stock may be volatile.

The market price of the Company’s common stock may be highly volatile, which may make it difficult for shareholders to resell their shares at the volume, prices and times desired. There are many factors that may affect the market price and trading volume of the Company’s common stock, including, without limitation:

Table

The stock market and especially the market for financial institution stocks have experienced substantial fluctuations in recent years, which in many cases have been unrelated to the operating performance and prospects of companies. In addition, significant fluctuations in the trading volume of the Company’s common stock may cause significant price variations to occur. Increased market volatility may materially and adversely affect the market price of the Company’s common stock and could make it difficult to sell shares at the volume, prices and times desired.

Future sales and issuances of the Company’s capital stock or rights to purchase capital stock could result in additional dilution of the percentage ownership of its shareholders.

The Company may issue additional securities in the future and from time to time, including as consideration in future acquisitions or under compensation or incentive plan. Future sales and issuances of the Company’s common stock or rights to purchase its common stock could result in substantial dilution to the Company’s existing shareholders. New investors in such subsequent transactions could gain rights, preferences and privileges senior to those of holders of the Company’s common stock. The Company may grant registration rights covering shares of its common stock or other securities in connection with acquisitions and investments.

The obligations associated with being a public company require significant resources and management attention.

As a public company, the Company’s legal, accounting, administrative and other costs and expenses are substantial. The Company is subject to the reporting requirements of the Exchange Act and the rules and regulations implemented by the SEC, the Sarbanes-Oxley Act of 2002, the Dodd-Frank Act, the Public Company Accounting Oversight Board, or PCAOB and the Nasdaq, each of which imposes additional reporting and other obligations on public companies. As a public company, compliance with these reporting requirements and other SEC and Nasdaq rules has made certain operating activities more time-consuming. Further, the Company’s reporting burden will increase when it no longer qualifies for the scaled disclosure allowed as an “emerging growth company” under the JOBS Act. When these exemptions cease to apply, the Company will likely incur additional expenses and devote increased management effort toward compliance.

The Company’s management and Board of Directors have significant control over its business.

The Company’s directors and named executive officers beneficially owned approximately 26.0% of its outstanding common stock as a group at December 31, 2021. Consequently, the Company’s management and board of directors may be able to significantly affect its affairs and policies, including the outcome of the election of directors and the potential outcome of other matters submitted to a vote of the Company’s shareholders, such as mergers, the sale of substantially all the Company’s assets and other extraordinary corporate matters. This influence may also have the effect of delaying or preventing changes of control or changes in management or limiting the ability of the Company’s other

Table

shareholders to approve transactions that they may deem to be in the best interests of the Company. The interests of these insiders could conflict with the interests of the Company’s other shareholders.

The holders of the Company’s debt obligations have priority over its common stock with respect to payment in the event of liquidation, dissolution or winding up and with respect to the payment of interest.

In the event of any liquidation, dissolution or winding up of the Company, its common stock would rank below all claims of debt holders against the Company. The Company’s debt obligations are senior to its shares of common stock. As a result, the Company must make payments on its debt obligations before any dividends can be paid on its common stock. In the event of bankruptcy, dissolution or liquidation, the holders of the Company’s debt obligations must be satisfied before any distributions can be made to the holders of the Company’s common stock. To the extent that the Company issues additional debt obligations, they will be of equal rank with, or senior to, the Company’s existing debt obligations and senior to shares of the Company’s common stock.

The Company may issue shares of preferred stock in the future.

The Company’s certificate of formation authorizes it to issue up to 10,000,000 shares of one or more series of preferred stock. The Company’s board of directors will have the authority to determine the preferences, limitations and relative rights of shares of preferred stock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by the Company’s shareholders. The Company’s preferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of its common stock. The potential issuance of preferred stock may delay or prevent a change in control of the Company, discourage bids for its common stock at a premium over the market price and materially adversely impact the market price and the voting and other rights of the holders of the Company’s common stock.

The Company is dependent upon the Bank for cash flow and the Bank’s ability to make cash distributions is restricted.

The Company’s primary tangible asset is the stock of the Bank. As such, the Company depends upon the Bank for cash distributions that it uses to pay its operating expenses, satisfy obligations and to pay dividends on its common stock. Federal statutes, regulations and policies restrict the Bank’s ability to make cash distributions to the Company. These statutes and regulations require, among other things, that the Bank maintain certain levels of capital in order to pay a dividend. Further, the OCC can restrict the Bank’s payment of dividends by supervisory action. If the Bank is unable to pay dividends to the Company, it will not be able to pay dividends on its common stock.

The Company’s dividend policy may change without notice and its future ability to pay dividends is subject to restrictions.

Although the Company has historically paid dividends to its shareholders, the Company has no obligation to continue doing so and may change its dividend policy at any time without notice to holders of its common stock. Holders of the Company’s common stock are only entitled to receive such cash dividends as its board of directors may declare out of funds legally available for such payments. Furthermore, consistent with the Company’s strategic plans, growth initiatives, capital availability, projected liquidity needs and other factors, the Company has made and will continue to make, capital management decisions and policies that could adversely impact the amount of dividends paid to holders of its common stock.

The Company is also subject to regulation by the Federal Reserve requiring that it inform and consult with the Federal Reserve prior to declaring and paying a dividend that exceeds earnings for the period for which the dividend is being paid or that could result in an adverse change to the Company’s capital structure, including interest on its debt obligations. If required payments on the Company’s debt obligations are not made or are deferred, or dividends on any preferred stock the Company may issue are not paid, the Company will be prohibited from paying dividends on its common stock.

In addition, the Company’s ability to declare or pay dividends is also subject to the terms of its loan agreement, which prohibits it from declaring or paying dividends upon the occurrence and during the continuation of an event of default. See “Part II.—Item 8.—Financial Statements and Supplementary Data—Note 11.”

Table

The Company’s corporate organizational documents and provisions of federal and state law to which it is subject contain certain provisions that could have an anti-takeover effect.

The Company’s certificate of formation and its bylaws (each as amended and restated) may have an anti-takeover effect and may delay, discourage or prevent an attempted acquisition or change of control or a replacement of the Company’s incumbent board of directors or management. The Company’s governing documents include provisions that:

In addition, certain provisions of Texas law, including a provision which restricts certain business combinations between a Texas corporation and certain affiliated shareholders, may delay, discourage or prevent an attempted acquisition or change in control. Furthermore, banking laws impose notice, approval and ongoing regulatory requirements on any shareholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or its holding company. These laws include the BHC Act and the CIBC Act. These laws could delay or prevent an acquisition.

Furthermore, the Company’s bylaws provide that the state or federal courts located in Jefferson County, Texas, the county in which Beaumont is located, will be the exclusive forum for: (i) any actual or purported derivative action or proceeding brought on the Company’s behalf; (ii) any action asserting a claim of breach of fiduciary duty by any of the Company’s directors or officers; (iii) any action asserting a claim against the Company or its directors or officers arising pursuant to the Texas Business Organizations Code, the Company’s certificate of formation, or its bylaws; or (iv) any action asserting a claim against the Company or its officers or directors that is governed by the internal affairs doctrine. Shareholders of the Company will be deemed to have notice of and have consented to the provisions of the Company’s bylaws related to choice of forum. The choice of forum provision in the Company’s bylaws may limit its shareholders’ ability to obtain a favorable judicial forum for disputes with it. Alternatively, if a court were to find the choice of forum provision contained in the Company’s bylaws to be inapplicable or unenforceable in an action, the Company may incur additional costs associated with resolving such action in other jurisdictions.

Item 1B. Unresolved Staff Comments

None.                                                                                                                                                    

​

​

Table

Item 2. Properties

The Bank operates 34 banking locations, all of which are in Texas. The headquarters of the Bank is located at 5999 Delaware Street, Beaumont, Texas 77706 and the telephone number is (409) 861-7200. A majority of the Company’s executives are located in Houston at 9 Greenway Plaza, Suite 110, Houston, Texas 77046 and the telephone number is (713) 210-7600. The Bank operates branches in the following Texas locations:

​

For the leased locations, the Company either leases the location entirely, owns the building and has a ground lease, or owns the drive-in and leases the branch. The Company believes that lease terms for the 10 branches that it leases are generally consistent with prevailing market terms. The expiration dates of the leases range from 2023 to 2045, without consideration of any renewal periods available.

​

​

Table

Item 3. Legal Proceedings

The Company is not currently subject to any material legal proceedings. The Company is from time to time subject to claims and litigation arising in the ordinary course of business.

At this time, in the opinion of management, the likelihood is remote that the impact of such proceedings, either individually or in the aggregate, would have a material adverse effect on the Company’s consolidated results of operations, financial condition or cash flows. However, one or more unfavorable outcomes in any claim or litigation against the Company could have a material adverse effect for the period in which they are resolved. In addition, regardless of their merits or their ultimate outcomes, such matters are costly, divert management’s attention and may materially and adversely affect the Company’s reputation, even if resolved in its favor.

Item 4. Mine Safety Disclosures

Not Applicable.

PART II.

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information for Common Stock

Shares of the Company’s common stock are traded on the Nasdaq under the symbol “CBTX”.

Holders of Record

As of February 18, 2022, there were approximately 511 holders of record of the Company’s common stock. Additionally, a greater number of holders of the Company’s common stock are “street name” or beneficial holders, whose shares are held by banks, brokers and other financial institutions.

Unregistered Sales of Equity Securities

None.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

In 2020, the Company’s board of directors authorized a share repurchase program, or the 2020 Repurchase Program, under which the Company could repurchase up to $40.0 million of the Company’s common stock starting October 1, 2020 through September 30, 2021. In 2021, the Company’s board of directors authorized a share repurchase program, or the 2021 Repurchase Program, under which the Company may repurchase up to $40.0 million of the Company’s common stock starting September 16, 2021 through September 30, 2022.

Repurchases under the 2021 Repurchase Program may be made from time to time at the Company’s discretion in open market transactions, through block trades, in privately negotiated transactions, and pursuant to any trading plan that may be adopted by the Company’s management in accordance with Rule 10b5-1 of the Exchange Act or otherwise. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions, and other corporate liquidity requirements and priorities. The repurchase program does not obligate the Company to acquire a specific dollar amount or number of shares and may be modified, suspended or discontinued at any time.

During 2021, 214,219 shares were repurchased under the Company’s share repurchase programs at an average price of $27.19 per share and during 2020, 431,814 shares were repurchased under the Company’s share repurchase programs at an average price of $20.62 per share. Shares repurchased in 2021 and 2020 were retired and returned to the status of authorized but unissued shares.

​

Table

The following table provides information with respect to purchases of shares of the Company’s common stock during the three months ended December 31, 2021 that the Company made or were made on behalf of the Company or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) under the Exchange Act.

​

Stock Performance Graph

The following performance graph compares total shareholder’s return on the Company’s common stock for the period beginning at the close of trading on November 7, 2017 and for the last trading date of each year from 2017 to 2021, with the cumulative total return of the Nasdaq Composite Index and the Nasdaq Bank Index for the same periods. Cumulative total return is computed by dividing the difference between the Company’s share price at the end and the beginning of the measurement period by the share price at the beginning of the measurement period. The performance graph assumes $100 is invested on November 7, 2017, in the Company’s common stock, including reinvestment of dividends and October 31, 2017 in the Nasdaq Composite Index and the Nasdaq Bank Index. Historical stock price performance is not necessarily indicative of future stock price performance. This performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC for purposes of Section 18 of the Exchange Act of 1934, or incorporated by reference into any future SEC filing, except as shall be expressly set forth by specific reference in such filing.

​

​

Item 6. Reserved

Table

​

​

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note Regarding Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements. These forward-looking statements reflect the Company’s current views with respect to, among other things, future events and the Company’s financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about the Company’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company’s control. Accordingly, the Company cautions that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.

There are or will be important factors that could cause the Company’s actual results to differ materially from those indicated in these forward-looking statements, including, but not limited to, the risks described in “Part I.—Item 1A. —Risk Factors” and the following:

Table

Pending Merger

On November 8, 2021, Allegiance (NASDAQ:ABTX) and the Company jointly announced that they entered into a definitive merger agreement pursuant to which the companies will combine in an all-stock merger of equals. Under the terms of the definitive merger agreement, Allegiance shareholders will receive 1.4184 shares of the Company’s common stock for each share of Allegiance common stock they own. Based on the number of outstanding shares of Allegiance and the Company as of November 5, 2021, Allegiance shareholders will own approximately 54% and the Company’s shareholders will own approximately 46% of the combined company. The companies have submitted the required regulatory filings and the parties anticipate closing in the second quarter of 2022.

​

There are or will be important factors that could cause the actual results of the merger to differ materially from those indicated in these forward-looking statements, including, but not limited to, the risks described in “Part I.—Item 1A. —Risk Factors”.

Table

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with Part IV.—Item 15.—Exhibits and Financial Statement Schedules” and the consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis includes forward-looking statements that are subject to certain risks and uncertainties and are based on certain assumptions that the Company believes are reasonable but may prove to be inaccurate. Certain risks, uncertainties and other factors, including those set forth in “Part I.—Item 1A.—Risk Factors” and elsewhere in this Annual Report on Form 10-K, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. The Company assumes no obligation to update any of these forward-looking statements.

Allegiance and the Company disclaim any obligation and do not intend to update or revise any forward-looking statements contained in this Annual Report on Form 10-K, which speak only as of the date hereof, whether as a result of new information, future events or otherwise, except as required by federal securities laws. As forward-looking statements involve significant risks and uncertainties, caution should be exercised against placing undue reliance on such statements.

​

Information about the Merger and Where to Find It

​

This Annual Report on Form 10-K does not constitute an offer to sell or the solicitation of an offer to buy any securities or a solicitation of any vote or approval.

​

In connection with the proposed merger, the Company has filed a registration statement on Form S-4 with the SEC to register the shares of the Company’s common stock that will be issued to Allegiance shareholders in connection with the merger. The registration statement will include a joint proxy statement/prospectus and other relevant materials in connection with the proposed merger, which will be sent to the shareholders of the Company and Allegiance seeking their approval of the proposed merger.

​

WE URGE INVESTORS AND SECURITY HOLDERS TO READ THE REGISTRATION STATEMENT ON FORM S-4, THE JOINT PROXY STATEMENT/PROSPECTUS INCLUDED WITHIN THE REGISTRATION STATEMENT ON FORM S-4 AND ANY OTHER RELEVANT DOCUMENTS FILED OR TO BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IN CONNECTION WITH THE PROPOSED MERGER BECAUSE

Table

THEY CONTAIN IMPORTANT INFORMATION ABOUT ALLEGIANCE, THE COMPANY AND THE PROPOSED MERGER.

​

Investors and security holders may obtain free copies of these documents, once they are filed, and other documents filed with the SEC by Allegiance or the Company through the website maintained by the SEC at https://www.sec.gov. Documents filed with the SEC by the Company will be available free of charge by accessing the Company’s website at www.communitybankoftx.com under the heading “Investor Relations” or, alternatively, by directing a request by mail or telephone to CBTX, Inc., 9 Greenway Plaza, Suite 110, Houston, Texas 77046, Attn: Investor Relations, (713) 210-7600, and documents filed with the SEC by Allegiance will be available free of charge by accessing Allegiance’s website at www.allegiancebank.com under the heading “Investor Relations” or, alternatively, by directing a request by mail or telephone to Allegiance Bancshares, Inc., 8847 West Sam Houston Parkway, N., Suite 200, Houston, Texas 77040, (281) 894-3200.

​

Participants in the Solicitation

The Company, Allegiance and certain of their respective directors and executive officers may be deemed to be participants in the solicitation of proxies from the shareholders of the Company and Allegiance in connection with the proposed merger. Certain information regarding the interests of these participants and a description of their direct or indirect interests, by security holdings or otherwise, will be included in the joint proxy statement/prospectus regarding the proposed merger when it becomes available. Additional information about the directors and executive officers of the Company and their ownership of the Company’s common stock is set forth in the Company’s proxy statement for its annual meeting of shareholders, filed with the SEC on April 14, 2021. Additional information about the directors and executive officers of Allegiance and their ownership of Allegiance’s common stock is set forth in Allegiance’s proxy statement for its annual meeting of shareholders, filed with the SEC on March 10, 2021. These documents can be obtained free of charge from the sources described above.

Overview

The Company operates through one segment. The Company’s primary source of funds is deposits and its primary use of funds is loans. Most of the Company’s revenue is generated from interest on loans and investments. The Company incurs interest expense on deposits and other borrowed funds as well as noninterest expense, such as salaries and employee benefits and occupancy expenses.

The Company’s operating results depend primarily on net interest income, calculated as the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Changes in market interest rates and the interest rates earned on interest-earning assets or paid on interest-bearing liabilities, as well as in the volume and types of interest-earning assets and interest-bearing liabilities, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets.

Periodic changes in the volume and types of loans in the Company’s loan portfolio are affected by, among other factors, economic and competitive conditions in Texas, as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within the Company’s target markets and throughout the state of Texas. The Company maintains diversity in its loan portfolio as a means of managing risk associated with fluctuations in economic conditions. The Company’s focus on lending to small to medium-sized businesses and professionals in its market areas has resulted in a diverse loan portfolio comprised primarily of core relationships. The Company carefully monitors exposure to certain asset classes to minimize the impact of a downturn in the value of such assets.

The Company seeks to remain competitive with respect to interest rates on loans and deposits, as well as prices on fee-based services, which are typically significant competitive factors within the banking and financial services industry. Many of the Company’s competitors are much larger financial institutions that have greater financial resources and compete aggressively for market share. Through the Company’s relationship-driven, community banking strategy, a significant portion of its growth has been through referral business from its existing customers and professionals in the Company’s markets including attorneys, accountants and other professional service providers.  

Table

On September 7, 2021, the Company was informed by the OCC that it terminated the Formal Agreement, between the Bank and the OCC regarding BSA/AML compliance matters. On December 16, 2021, the Bank entered into an OCC Consent Order regarding BSA/AML compliance matters. Under the OCC Consent Order, the Bank paid a civil money penalty of $1.0 million.

On December 15, 2021, the Bank entered into the FinCEN Consent Order. Under the terms of the FinCEN Consent Order, the Bank paid a civil money penalty of $8.0 million; provided, however, that FinCEN agreed to credit the Bank the $1.0 million civil money penalty imposed by the OCC described above. As a result, the Bank paid an aggregate sum of $8.0 million under the OCC Consent Order and the FinCEN Consent Order. The OCC Consent Order and the FinCEN Consent Order each settle the civil money proceedings against the Bank initiated by the OCC and FinCEN. See “Item 1A.—Risk Factors.”

​

Information Regarding COVID-19 Impact and Uncertain Economic Outlook

The COVID-19 pandemic and actions taken in response to it, combined with the sustained instability in the oil and gas industry, negatively impacted the global economy and financial markets. The Company’s markets, including its primary markets in Houston and Beaumont are particularly subject to the financial impact of the sustained instability in the oil and gas industry. Although oil prices increased in January 2022, the industry remains in a downturn. As a result of these factors and the impact on the loan portfolio, the Company increased the ACL and provision for credit losses during 2020, which negatively impacted the Company’s net income and due to improvements in the national and local economies and related forecasts and the reduction of the loan portfolio, the Company reduced the ACL in during 2021. The future impact of the COVID-19 pandemic is uncertain but could materially affect the Company’s future financial and operational results. See “Part I.—Item 1A.—Risk Factors.”

​

Table

The risk grades of the Company’s loan portfolio, past due loans, loans individually evaluated and nonperforming loans, or loan performance indicators, as of the dates indicated below were as follows:

​

The table above shows the trend of loan performance indicators over the past five reporting periods. Loan performance indicators reflected worsening loan performance during 2020, primarily as a result of the impact of the COVID-19 pandemic and sustained instability in the oil and gas industry on the Company’s borrowers. Substantially all of the loan performance indicators have shown improvement during 2021. Although national and local economies and economic forecasts improved during 2021, the COVID-19 pandemic continues to have an ongoing impact through supply disruptions and other uncertainties and the oil and gas industry is still experiencing instability. If the national and/or local economies and economic forecasts and loan performance indicators worsen in the future, increases in the ACL through additional provisions for credit losses may occur which would negatively impact net income.

​

In support of customers impacted by the COVID-19 pandemic, the Company offered relief through payment deferrals during 2020 and 2021. A majority of borrowers with deferral arrangements have returned to normal contractual payment schedules and the Company continues to provide deferred payment arrangements to a small number of businesses. The Company had 7 loans subject to such deferral arrangements with outstanding principal balances of $18.5 million at December 31, 2021 and 21 loans on deferral arrangements with total outstanding principal balances totaling $38.4 million at December 31, 2020.

​

Table

During the years ended December 31, 2021 and 2020, the Company participated in PPP lending under the CARES Act, which facilitates loans to small businesses See “Part II.—Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Loan Portfolio” and “Part I. —Item 1A.—Risk Factors.”

Results of Operations

Year Ended December 31, 2021 vs Year Ended December 31, 2020

The increase in net income during the year ended December 31, 2021, compared to the year ended December 31, 2020, was primarily due to fluctuations in the provision (recapture) for credit losses, increased noninterest expense, decreased net interest income, increased noninterest income and increased income tax expense. See further analysis of the material fluctuations in the related discussions that follow.

​

​

Net Interest Income

Net interest income decreased $2.4 million during the year ended December 31, 2021, compared to the year ended December 31, 2020, primarily due to lower average loans, lower rates on interest-earning assets and higher average interest-bearing deposits, which was partially offset by higher average securities and interest-bearing deposits at other financial institutions and lower rates on interest-bearing deposits.

The yield on interest-earning assets was 3.43% for the year ended December 31, 2021, compared to 3.98% for the year ended December 31, 2020. The cost of interest-bearing liabilities was 0.31% for the year ended December 31, 2021 and 0.57% for the year ended December 31, 2020. The Company’s net interest margin on a tax equivalent basis was 3.31% for the year ended December 31, 2021, compared to 3.73% for the year ended December 31, 2020. Yields on interest-earning assets decreased and the costs of interest-bearing liabilities did not decrease to the same extent, which caused compression of the Company’s net interest margin on a tax equivalent basis during 2021. Although competitive pressures have caused the costs of interest-bearing deposits to not drop in tandem with decreases in market rates for interest-earning assets, they remain a low-cost source of funds, as compared to other sources of funds.

The yield on loans for the years ended December 31, 2021 and 2020 was impacted by the Company’s participation in PPP financing. The Company recognized a net yield of 5.80% and 2.79% on PPP loans during the years ended December 31, 2021 and 2020, respectively. Without PPP loans, the Company’s average yield on loans would have been 4.39% and 4.75% for those same periods.

Interest earned on PPP loans for the years ended December 31, 2021 and 2020 included the recognition of $8.4 million and $4.0 million, respectively, of origination fee income, net of associated costs, related to PPP loans. At December 31, 2021 and 2020, the Company had $1.5 million and $4.2 million of deferred loan fees and costs related to PPP loans outstanding.

​

Table

The following table presents for the periods indicated, average outstanding balances for each major category of interest-earning assets and interest-bearing liabilities, the interest income or interest expense and the average yield or rate for the periods indicated below.

​

​

​

Table

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