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TABLE OF CONTENTS
INDEX TO FINANCIAL STATEMENTS
As filed with the Securities and Exchange Commission on October 30, 2017
Registration No. 333-220930
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Amendment No. 1
to
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
CBTX, INC.
(Exact Name of Registrant as Specified in Its Charter)
| Texas (State or Other Jurisdiction of Incorporation or Organization) |
6021 (Primary Standard Industrial Classification No.) |
20-8339782 (I.R.S. Employer Identification No.) |
9 Greenway Plaza, Suite 110
Houston, Texas 77046
(713) 210-7600
(Address, Including Zip Code, of Registrant's Principal Executive Offices)
Robert R. Franklin, Jr.
Chairman, President and Chief Executive Officer
9 Greenway Plaza, Suite 110
Houston, Texas 77046
(713) 210-7600
(Name, Address and Telephone Number, Including Area Code, of Agent For Service)
| Copies to: | ||
Justin M. Long, Esq. Michael G. Keeley, Esq. Norton Rose Fulbright US LLP 98 San Jacinto Blvd., Suite 1100 Austin, TX 78701 (512) 474-5201 (512) 536-4598 (facsimile) |
Frank M. Conner III, Esq. Michael P. Reed, Esq. Christopher J. DeCresce, Esq. Covington & Burling LLP One CityCenter 850 Tenth Street, NW Washington, DC 20001 (202) 662-6000 (202) 662-6291 (facsimile) |
|
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. o
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer ý (Do not check if a smaller reporting company) |
Smaller reporting company o Emerging growth company ý |
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 7(a)(2)(B) of the Securities Act. ý
CALCULATION OF REGISTRATION FEE
|
||||||||
| Title of Each Class of Securities to be Registered |
Amount to be Registered(1) |
Proposed Maximum Price per Share(2) |
Proposed Maximum Aggregate Offering Price(2) |
Amount of Registration Fee(3) |
||||
|---|---|---|---|---|---|---|---|---|
Common Stock, $0.01 par value per share |
2,760,000 | $26.00 | $71,760,000 | $8,935 | ||||
|
||||||||
- (1)
- Includes
360,000 shares of common stock that the underwriters have the option to purchase from the Registrant in this offering.
- (2)
- Estimated
solely for purposes of computing the amount of the registration fee pursuant to Rule 457(a) under the Securities Act of 1933, as amended.
- (3)
- Of this amount, $6,225 has been previously paid by the Registrant.
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file an amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.
The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.
Subject to completion, dated October 30, 2017
PRELIMINARY PROSPECTUS
2,400,000 Shares
CBTX, Inc.
Common Stock
This prospectus relates to the initial public offering of CBTX, Inc.'s common stock. We are the bank holding company for CommunityBank of Texas, N.A., with operations in Houston and Beaumont, Texas. We are offering 2,400,000 shares of our common stock.
Prior to this offering there has been no established public market for our common stock. We currently estimate that the initial public offering price of our common stock will be between $24.00 and $26.00 per share. We have applied to list our common stock on the Nasdaq Global Select Market under the symbol "CBTX."
Investing in our common stock involves a high degree of risk. See "Risk Factors" beginning on page 18.
We are an "emerging growth company" as defined in the Jumpstart Our Business Startups Act of 2012, and are subject to reduced public company reporting requirements. See "Implications of Being an Emerging Growth Company."
| |
Per share | Total | ||
|---|---|---|---|---|
Initial public offering price |
$ | $ | ||
Underwriting discounts(1) |
$ | $ | ||
Proceeds, before expenses, to us |
$ | $ |
- (1)
- See "Underwriting" for additional information regarding underwriting discounts and certain expenses payable to the underwriters by us.
We have granted the underwriters an option to purchase up to an additional 360,000 shares of our common stock at the initial public offering price, less underwriting discounts, within 30 days from the date of this prospectus.
Neither the Securities and Exchange Commission, nor any other state securities commission nor any other regulatory authority has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
Our common stock is not a deposit or savings account. Our common stock is not insured by the Federal Deposit Insurance Corporation or any other governmental agency or instrumentality.
The underwriters expect to deliver the shares of our common stock to purchasers on or about , 2017, subject to customary closing conditions.
| Stephens Inc. | Keefe, Bruyette & Woods | |
| A Stifel Company | ||
| Sandler O'Neill + Partners, L.P. |
||
The date of this prospectus is , 2017
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You should rely only on the information contained in this prospectus and any free writing prospectus prepared by us or on our behalf that we have referred you to. We and the underwriters have not authorized anyone to provide you with additional or different information. If anyone provides you with additional, different or inconsistent information, you should not rely on it. We and the underwriters take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares offered hereby, and only under circumstances and in jurisdictions where it is lawful to do so. We are not making an offer of these securities in any state, country or other jurisdiction where the offer is not permitted. You should not assume that the information in this prospectus or any free writing prospectus is accurate as of any date other than the date of the applicable document regardless of its time of delivery or the time of any sales of our common stock. Our business, financial condition, results of operations and cash flows may have changed since the date of the applicable document.
In this prospectus, unless otherwise indicated or the context otherwise requires, all references in this prospectus to "we," "our," "us," "ourselves," and "the Company" refer to CBTX, Inc., a Texas corporation, and its consolidated subsidiaries. All references in this prospectus to "CommunityBank of Texas" or "the Bank" refer to CommunityBank of Texas, N.A., our wholly-owned bank subsidiary. Additionally, references in this prospectus to "Houston" refer to the Houston-The Woodlands-Sugar Land Metropolitan Statistical Area, or MSA, and surrounding counties. References in this prospectus to "Beaumont" refer to the Beaumont-Port Arthur MSA and surrounding counties.
This prospectus describes the specific details regarding this offering and the terms and conditions of our common stock being offered hereby and the risks of investing in our common stock. For additional information, please see the section entitled "Where You Can Find More Information."
You should not interpret the contents of this prospectus to be legal, business, investment or tax advice. You should consult with your own advisors for that type of advice and consult with them about the legal, tax, business, financial and other issues that you should consider before investing in our common stock.
Unless otherwise stated, all information in this prospectus gives effect to a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each share owned as of the record date of September 30, 2017, in the form of a stock dividend that was distributed on October 13, 2017. The effect of the stock dividend on outstanding shares and per share figures has been retroactively applied to all periods presented in this prospectus.
Unless otherwise stated, all information in this prospectus assumes that the underwriters have not exercised their option to purchase additional shares of our common stock.
This prospectus includes industry and trade association data, forecasts and information that we have prepared based, in part, upon data, forecasts and information obtained from independent trade associations, industry publications and surveys, government agencies and other independent information publicly available to us. Statements as to our market position are based on market data currently available to us. Industry publications and surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable. Although we believe these sources are reliable, we have not independently verified the information. Some data is also based on our good faith estimates, which are derived from management's knowledge of the industry and independent sources. We believe our internal research is reliable, even though such research has not been verified by any independent sources. While we are not aware of any misstatements regarding our industry data presented herein, our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under the heading "Risk Factors" in this prospectus. Trademarks used in this prospectus are the property of their respective owners, although for presentational convenience we may not use the ® or the ™ symbols to identify such trademarks.
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IMPLICATIONS OF BEING AN EMERGING GROWTH COMPANY
We are an "emerging growth company" as defined in the Jumpstart our Business Startups Act of 2012, or the JOBS Act. For as long as we are an emerging growth company, unlike other public companies that are not emerging growth companies under the JOBS Act, we are not required to:
- •
- provide an auditor's attestation report on management's assessment of the effectiveness of our system of internal control over financial
reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act;
- •
- provide more than two years of audited financial statements and related management's discussion and analysis of financial condition and results
of operations;
- •
- comply with any new requirements adopted by the Public Accounting Oversight Board, or the PCAOB, requiring mandatory audit firm rotation or a
supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer;
- •
- provide certain disclosure regarding executive compensation required of larger public companies or hold shareholder advisory votes on executive
compensation as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act; or
- •
- obtain shareholder approval of any golden parachute payments not previously approved.
We will cease to be an "emerging growth company" upon the earliest of:
- •
- the last day of the fiscal year in which we have $1.07 billion or more in total annual gross revenues;
- •
- the date on which we become a "large accelerated filer" (the fiscal year end on which the total market value of our common equity securities
held by non-affiliates is $700 million or more as of June 30);
- •
- the date on which we issue more than $1.00 billion of non-convertible debt over a three-year period; or
- •
- the last day of the fiscal year following the fifth anniversary of our initial public offering.
We have elected to adopt the reduced disclosure requirements above for purposes of the registration statement of which this prospectus is a part. In addition, we expect to take advantage of certain of the reduced reporting and other requirements of the JOBS Act with respect to the periodic reports we will file with the Securities and Exchange Commission, or the SEC, and proxy statements that we use to solicit proxies from our shareholders.
In addition, Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, or the Securities Act, for complying with new or revised accounting standards, but we have irrevocably opted out of the extended transition period, and as a result, we will adopt new or revised accounting standards on the relevant dates in which adoption of such standards is required for other public companies.
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This summary highlights selected information contained elsewhere in this prospectus and may not contain all of the information that you should consider before investing in our common stock. You should carefully read the entire prospectus, including the sections entitled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," together with our consolidated financial statements and the related notes that are included herein, before making an investment decision. Additionally, references in this prospectus to "Houston" refer to the Houston-The Woodlands-Sugar Land Metropolitan Statistical Area, or MSA, and surrounding counties. References in this prospectus to "Beaumont" refer to the Beaumont-Port Arthur MSA and surrounding counties. Unless otherwise stated, all information in this prospectus gives effect to a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each share owned as of the record date of September 30, 2017, in the form of a stock dividend that was distributed on October 13, 2017. The effect of the stock dividend on outstanding shares and per share figures has been retroactively applied to all periods presented in this prospectus.
We are a bank holding company that operates through our wholly-owned subsidiary, CommunityBank of Texas, in Houston and Beaumont, Texas. We focus on providing commercial banking solutions to local small and mid-sized businesses and professionals in our markets. Our market expertise, coupled with a deep understanding of our customers' needs, allows us to deliver tailored financial products and services. As of June 30, 2017, we had total assets of $2.9 billion, total loans of $2.2 billion, total deposits of $2.5 billion and total shareholders' equity of $372.0 million.
Our vision and focus is to continue to build a premier business bank that combines the sophisticated banking products of a large financial institution with the personalized service of a community bank. Our management team and board of directors, led by our Chairman, President and Chief Executive Officer, Robert R. Franklin, Jr., have extensive commercial banking experience as well as long-term relationships and deep ties in the markets we serve. We believe that our future growth and profitability will be predicated on the successful execution of our relationship-driven business model and our ongoing commitment to understanding and meeting the needs of our customers. In addition, we expect that recent investments in our infrastructure and the hiring of additional experienced banking professionals will facilitate growth and increased profitability. While we are primarily focused on organic growth, we plan to pursue strategic acquisitions as an additional means of increasing scale, profitability and shareholder value.
We are a Texas corporation that was incorporated on January 26, 2007. We were originally founded by a group of Beaumont business and community leaders, including Pat Parsons as our Chief Executive Officer. We began operations in 2007 with the acquisition of CountyBank, N.A., an institution with $130 million in assets with operations in Beaumont and surrounding counties. Mr. Parsons and our other founders envisioned a community bank in Beaumont committed to creating long-term relationships with small and mid-sized businesses and professionals. Our management and board had a long-term strategic vision to expand the Bank's presence west into Houston through strategic acquisitions, hiring experienced banking professionals, and focused de novo branching.
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Today, our company reflects the successful execution of our vision, as we have built and expanded into the attractive Houston market and have added experience and depth to our leadership team. Our merger and acquisition and expansion history includes the following:
Franchise Expansion and Market Extension
The following illustrations reflect the transformation of our loan portfolio from year-end 2009 through June 30, 2017 and highlight our successful expansion into the Houston market.
We have utilized our strategic mergers to add valuable members to our team, including to our executive management team. Our current Chairman, President and Chief Executive Officer, Robert R. Franklin, Jr., Chief Financial Officer, Robert "Ted" Pigott, Jr., Chief Credit Officer, Joe F. West and Chief Risk Officer, James L. Sturgeon, joined us through our merger of equals with VB Texas, Inc. In addition, we believe we have been successful in our mergers in retaining key personnel throughout our organization, including in key areas such as lending, human resources and compliance.
In addition to mergers and acquisitions, we have strategically added to our branch footprint by opening de novo locations around teams of seasoned lenders with a realistic plan to achieve branch profitability in a short period of time. We intend to continue to seek out experienced lenders and lending teams around whom we will build necessary infrastructure, including de novo branches if appropriate, to facilitate such lenders' success and integration into our franchise.
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We are focused on controlled, profitable growth. Our track record demonstrates this ability, as illustrated in the following chart. Since December 31, 2009, our total assets increased from approximately $1.3 billion to approximately $2.9 billion as of June 30, 2017, and our return on average assets improved from 0.16% for the year ended December 31, 2009 to 1.08% for the six months ended June 30, 2017. We believe that there are significant ongoing growth opportunities for us in our markets.
Assets and Earnings Growth
(Dollars in millions)
We believe our competitive strengths include the following:
Deep and Experienced Management Team. Our Chairman, President and Chief Executive Officer, Robert R. Franklin, Jr., our Vice Chairman Pat Parsons, and our Chief Financial Officer, Robert "Ted" Pigott, Jr., have more than 115 years of combined experience acquiring, growing, operating and selling banks within our markets. Certain biographical information for our selected senior executives is as follows:
Robert R. Franklin, Jr., Chairman, President and Chief Executive Officer. Mr. Franklin began his 36-year Houston banking career working for a small community bank in Houston upon graduation from the University of Texas. He then moved to a large, regional bank before gravitating back to his primary interest of community banking. He became President of American Bank in 1988 where he served until the bank was sold to Whitney Holding Corp. in early 2001. Mr. Franklin and his team then joined Horizon Capital Bank where Mr. Franklin raised sufficient capital to match the bank's existing capital and took the position of President. He served as President until the bank was sold to Cullen/Frost Bankers, Inc. in 2005. Mr. Franklin then started VB Texas, Inc. in November of 2006 as Chairman, President and Chief Executive Officer, serving until a "merger of equals" between VB Texas, Inc. and CBTX, Inc. in 2013, where he currently serves as Chairman, President and Chief Executive Officer.
Pat Parsons, Vice Chairman of the Board. Mr. Parsons has 44 years of banking experience and served as the founding Chairman and Chief Executive Officer of CommunityBank of Texas, and the President and Chief Executive Officer of CBTX, Inc. for seven years. He began his banking career in 1973 with First City National Bank of Houston as a Management Trainee and has served in various capacities at numerous commercial banks within our market areas, including Community Bank & Trust, SSB, as President and Chief Operating Officer. From 1992 to 2004, Mr. Parsons oversaw Community Bank & Trust, SSB's expansion, through organic growth and five acquisitions, to over $1.1 billion in assets and a network spanning 15 Southeast Texas communities. In 2004, Community Bank & Trust, SSB was acquired by Texas Regional Bancshares, Inc.
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Robert "Ted" Pigott, Jr., Chief Financial Officer. Mr. Pigott has over 35 years of commercial banking experience, having served as Chief Financial Officer for both privately held and publicly-traded Texas banking institutions in the Houston, Dallas/Fort Worth, Austin and McAllen markets, including Texas Regional Bancshares, Inc. Mr. Pigott joined VB Texas, Inc. as Chief Financial Officer in 2010 and became our Chief Financial Officer in 2013 following the merger of CBTX, Inc. and VB Texas, Inc. He also spent six years in public accounting with Arthur Andersen & Co., a national accounting firm.
The Bank is managed by an executive committee consisting of ten highly qualified and experienced bankers with an average of 38 years of banking experience. The members of the executive committee oversee various aspects of our organization including lending, credit administration, treasury services, finance, operations, information technology, regulatory compliance and risk management. Additionally, we have four regional CEOs with an average of 27 years of banking experience who oversee loan and deposit production and performance in their respective markets. Our team has a demonstrated track record of achieving profitable growth, maintaining a strong credit culture, implementing a relationship-driven approach to banking and successfully executing acquisitions.
We believe our continued growth and success will benefit from a commitment to developing our next generation of bankers. Our commitment to talent development includes a mentorship program, which provides our junior bankers with an opportunity to take a hands-on approach to interacting with our customers and learning directly from our successful senior banking team members. We also provide formal in-house training for our junior bankers, which enhances their professional experience and provides for greater organic growth opportunities and employee retention. We believe that our commitment to the development of talent leads to long-term continuity and the recruitment and retention of high quality bankers in our markets. These aspects lay the foundation for the long-term growth potential of the Bank.
Strength of Our Operating Markets. As further described in "Our Market Areas" below, we believe that our two primary markets provide us with an advantage over other community banks in Texas in terms of growing our loans and deposits, as well as increasing profitability and building shareholder value. Houston is the fastest growing major MSA in the country measured by population growth. With an estimated population of approximately 7.0 million people living in a diverse economy with a robust job market, we believe it is one of the most dynamic banking markets in the country. Our management, team of lenders and well positioned branch network should afford us the ability to capitalize on the projected growth in the Houston MSA.
Our team's history of operating successful banking institutions in the Beaumont market spans decades, and we have a strong reputation for delivering superior service in the market. Our deep ties to the community have led to a dominant market share, and we are ranked number one in deposits in the Beaumont-Port Arthur MSA, with over 20% market share as of June 30, 2017. Our branches in the Beaumont-Port Arthur MSA provide a stable, low-cost core funding base of approximately $1.1 billion in deposits.
True Relationship-Based Community Banking. We believe that banking is a profession, and we expect our bankers to be more than just salesmen. With an active knowledge of our markets and skilled analytical capabilities, our bankers serve as financial partners to our customers, helping them to grow their businesses. We strive to provide complete and comprehensive loan and deposit options to our customers, and we believe that the most effective way to win business is to develop relationships with our customers by spending time with them at their places of business. Our bankers make these customer visits a priority, and we take a team-based approach by including treasury services professionals and senior management on many customer meetings. Our bankers strive to gain a comprehensive understanding of how our customers' businesses operate, which helps us craft financial solutions to fulfill their needs. We are active and diligent in this effort to organically source business, as we believe it allows us to be more selective in our approach to lending. As a testament to our
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relationship approach to banking, as of June 30, 2017, approximately 83% of our loan customers also have deposit relationships with us.
Growing Core Deposit Franchise. Noninterest-bearing deposits represented 40.96% of our total deposits as of June 30, 2017, and our cost of deposits was 0.30% for the first six months of 2017. Developing low-cost deposit relationships with our business customers is a key component of our growth strategy. Our strong deposit base serves as a major driver of our operating results, as we utilize our core deposits primarily to fund our loan growth. We believe that our relationship-based approach to banking, combined with our ability to offer a full suite of sophisticated treasury services, enhances our ability to source low-cost, core deposits to fund organic growth.
Maintain Strong Asset Quality. Preserving sound credit underwriting standards as we grow our loan portfolio will continue to be integral to our strategy. We place a considerable emphasis on effective risk management as an essential component of our organizational culture. We use our risk management infrastructure to monitor existing operations, support decision-making and improve the success rate of new initiatives. To maintain strong asset quality, we employ centralized and thorough loan underwriting, a diversified loan portfolio and highly experienced credit officers and credit analysts, including two Regional Credit Officers, one for each of our primary markets. We believe the long-term success of our business hinges on maintaining sound credit quality. Our nonperforming assets to total assets ratio was 0.52% as of December 31, 2015, 0.27% as of December 31, 2016 and 0.33% as of June 30, 2017.
Proven Ability to Acquire and Integrate Banks. We have completed five whole-bank acquisitions and, as a result, we believe we have developed an experienced and disciplined acquisition and integration approach capable of identifying candidates, conducting thorough due diligence, determining financial attractiveness and integrating the acquired institution. We believe that we have built a corporate infrastructure capable of supporting additional continued growth both organically and through strategic acquisitions. Our acquisition experience and our reputation as a successful acquirer should position us well to capitalize on additional opportunities in the future.
Our executive management team and board of directors have focused on building a premier banking franchise that is capable of yielding sustainable growth and long-term profitability that enhances value for our shareholders, which we intend to accomplish through:
Strong Credit Culture. Our approach to credit begins with a thorough understanding of our customers' businesses. When underwriting a potential lending opportunity, we analyze our customer's balance sheet with a focus on liquidity, and the income statement with emphasis on cash flow and the cash cycle of the business. Additionally, we receive personal guarantees from the principal or principals on the majority of our commercial credits. All credit relationships greater than $1.0 million must be approved by our internal loan committee, and all credit relationships greater than $2.5 million must be approved by the Bank's active Directors Loan Committee, which meets twice per week.
Our credit officers are involved in the underwriting structuring and pricing process at inception of the lending opportunity and remain involved through approval. We manage risk in the portfolio with prudent underwriting and proactive credit administration, utilizing a Regional Credit Officer and credit analysts located in each of our two primary markets. Furthermore, we believe our individual lending authority is low relative to our peers. This combined with the Bank's active Directors Loan Committee allows us to maintain centralized underwriting, which we believe gives us consistency across our loan portfolio and allows us to be responsive to our customers' timing needs.
Diversified Loan Portfolio. Our focus on lending to small to medium-sized businesses and professionals in our market areas results in a diverse loan portfolio comprised primarily of core relationships, where our bankers support clients through tailored financial solutions. Additionally, we
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carefully monitor exposure to certain asset classes to minimize the impact of a downturn in the value of such assets. Finally, we are currently expanding our commercial and industrial, medical and SBA lending products as we see an attractive opportunity and believe this will further diversify our loan portfolio across lending verticals.
Comprehensive Suite of Financial Solutions. We provide a comprehensive suite of financial solutions that competes with large, national competitors, but with the personalized attention and nimbleness of a relationship-focused community bank. We offer a full range of banking products, including commercial and industrial loans (including equipment loans and working capital lines of credit), commercial real estate loans (including owner-occupied and investor real estate loans), construction and development loans, SBA loans, treasury services and commercial deposits. Other banking products we offer include traditional retail deposits, mortgage origination and online banking. We have recently expanded our treasury services platform by hiring additional personnel in order to more effectively provide treasury services solutions to our customers. We believe our clients prefer to obtain their banking services from local institutions able to provide the sophistication of larger banks, but with a local and agile decision-making process, personal connections, and an interest in investing in the local economy and community. This also allows us to gather core, low-cost deposit relationships, high credit quality loans and fee income generated by value-added services.
Organic Growth. We aim to continuously enhance our customer base, increase loans and deposits and expand our overall market share, and believe that Houston specifically has significant organic growth opportunities. Through the successful implementation of our relationship-driven, community banking strategy, a significant portion of our organic growth has been through referral business from our current customers and professionals in our markets including attorneys, accountants and other professional service providers. We plan to continue our organic growth by leveraging the extensive experience of our board of directors, executive management team and senior bankers, all of which give us market insight and familiarity with our customers. By understanding our customers' businesses, appropriately structuring our loans, and applying a solution-minded approach and attitude to our customers' needs, we believe that we will continue to attract customers who value our approach of being their financial partners. Our team of seasoned bankers has been, and will continue to be, an important driver of our organic growth by further developing banking relationships with current and potential customers.
We have a track record of hiring experienced bankers to enhance our organic growth, and sourcing and hiring talent will continue to be a core focus for us. We believe that this initial public offering will enhance our ability to attract and retain this talent. We have identified areas of opportunity within certain lending verticals and plan to hire additional bankers to focus on these efforts. While we currently offer commercial and industrial, medical and SBA lending products, we have recently added bankers focused on these products in order to expand in these verticals.
Strategic Acquisitions. We intend to continue to supplement our organic growth through strategic acquisitions, and we believe obtaining a publicly traded common stock will improve our ability to compete for these opportunities. Many small to medium-sized banking organizations face significant scale and operational challenges, regulatory pressure, management succession issues and shareholder liquidity needs. Although we have no current plans, arrangements or understandings to make any material acquisitions, we expect our markets will afford us opportunities to identify and execute acquisitions designed to strengthen our franchise and increase shareholder value. In addition to meeting our financial thresholds, we place critical importance on the target contributing meaningful strategic enhancements, including talented bankers that will be additive to our franchise, a sound credit culture and a complementary branch footprint.
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Increase Operational Efficiency. We are focused on improving our operational efficiency and expect these efforts to drive future profitability and increase shareholder value. We have upgraded our operating capabilities and created a platform for continued efficiencies in the areas of risk management, technology, data processing, regulatory compliance and human resources that is capable of handling our continued growth, which we believe will help us to achieve increased scale without incurring significant incremental noninterest expense. In addition, we have streamlined our branch footprint by closing three smaller branches and utilizing our central Houston location. This centralized corporate lending structure combined with our robust treasury services, which has led to approximately 83% of our loan customers having deposit relationships with us as of June 30, 2017, provides us with a more efficient path to profitable growth. Our efficiency ratio has improved from 67.8% for the year ended December 31, 2012, to 62.7% for the year ended December 31, 2016, and was 62.8% for the six months ended June 30, 2017.
Our net income increased from $11.4 million in 2012 to $27.2 million in 2016, for a compound annual growth rate, or CAGR, of 24.2%, and our return on average assets improved from 0.74% in 2012 to 0.94% in 2016. For the six months ended June 30, 2017, our net income was $15.6 million compared to $12.9 million for the six months ended June 30, 2016, and our return on average assets improved to 1.08% from 0.92% over the same time periods, respectively.
In addition to continued improvements in our operational efficiencies, we expect our profitability to increase in a rising interest rate environment due to our asset-sensitive balance sheet, which has resulted from our focus on commercial and industrial lending and the quality of our deposit franchise. As of June 30, 2017, 58.3% of our loans had a variable interest rate, and we believe we are well positioned to experience net interest margin expansion in a rising rate environment.
We classify our branch footprint in two primary market areas, Houston and Beaumont. We have 18 branches located in Houston, and our Beaumont presence, concentrated in Southeast Texas, includes 16 branches.
Houston Metropolitan Area
The Houston MSA is comprised of nine counties spanning over nine thousand square miles. The Houston MSA has the fifth largest population nationwide based on estimated 2018 population statistics provided by Nielsen. Houston is poised for continued robust growth, and ranks first for projected five-year population growth through 2023 among the 25 largest MSAs in the United States, according to Nielsen. According to the Greater Houston Partnership, Houston's 2015 gross domestic product, or GDP, of $503 billion ranks it as the fourth largest economy in the United States and would rank it as the 26th largest economy for a country in the world.
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Population (millions) | |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|
Top 5 Growth Growth Rank |
Top 5 Large MSAs by Population Growth | 2018 Estimated |
2023 Projected |
Population % D |
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1 |
Houston-The Woodlands-Sugar Land, TX | 7.0 | 7.6 | 8.3 | % | |||||||
2 |
Orlando-Kissimmee-Sanford, FL | 2.5 | 2.7 | 8.2 | % | |||||||
3 |
San Antonio-New Braunfels, TX | 2.5 | 2.7 | 8.1 | % | |||||||
4 |
Dallas-Fort Worth-Arlington, TX | 7.4 | 8.0 | 7.7 | % | |||||||
5 |
Denver-Aurora-Lakewood, CO | 2.9 | 3.2 | 7.7 | % | |||||||
|
Texas | 28.5 | 30.6 | 7.1 | % | |||||||
|
Nationwide | 326.5 | 337.9 | 3.5 | % | |||||||
We believe that our 18 branches are strategically located throughout Houston, which will help drive loan growth and improve deposit market share as we execute our strategy.
7
Attractive Business Climate. The favorable business environment in Texas includes a large and growing workforce, low business tax, no personal income tax and a reasonable cost of housing, which has resulted in business relocation to the state, and to Houston, in particular. Houston is the home of 20 Fortune 500 companies.
Sizable Workforce and Diverse Job Market. According to the Greater Houston Partnership, there are approximately three million jobs in Houston, which is greater than 35 states combined. While energy companies contribute significantly to Houston's GDP, the economy in Houston has become more diverse over the last three decades and several industries contribute to the economy's growth and diversification. Major industries for employment include energy, healthcare, transportation, manufacturing, education and finance. The Texas Medical Center is the world's largest medical complex, with industry leading specialties in research and treatment for cancer and cardiovascular disease. Growth of the medical center remains robust and there are currently approximately $3 billion in medical construction projects underway.
Strategic Location. Houston's location in the South Central U.S. along the Gulf of Mexico provides businesses and individuals with unmatched access to all modes of transportation and a centralized location with efficient access to other areas of the country. In 2015, the Port of Houston ranked first in both export and import tonnage among all U.S. ports, and second in total tonnage, according to the Greater Houston Partnership. Houston also boasts two international airports which offered non-stop flights to 124 domestic destinations and 74 international destinations in 2016. In 2015, the Houston Airport System processed over 441 metric tons of air freight and served over 55 million travelers, according to the Greater Houston Partnership.
Beaumont Market Area
Our deep ties to the Beaumont area and long history of providing tailored financial products and services have led us to become the market share leader in the Beaumont-Port Arthur MSA in terms of deposits, with over 20% market share as of June 30, 2017. Our branches in the Beaumont-Port Arthur MSA, which is located adjacent to Houston, approximately 85 miles east of downtown Houston, provide a stable, low-cost core funding base of approximately $1.1 billion in deposits. Our Beaumont footprint includes 12 branches located in Beaumont and four located in its surrounding areas.
The cities of Beaumont, Port Arthur and Orange are all located in the Beaumont-Port Arthur MSA and form what is known as the "Golden Triangle," a major industrial and petrochemical complex located on the Gulf of Mexico, according to Forbes. Other leading industries in the market include transportation, defense and education. Petrochemical production and processing has grown significantly along the Gulf of Mexico in recent years, as six of the eight new U.S. ethylene projects under construction are being built on the Texas Gulf Coast, according to the Beaumont Enterprise. Beaumont has benefitted from the growth in the industry, as ExxonMobil recently announced the expansion of its Beaumont polyethylene plant by 65%, which is expected to add 1,400 jobs to the local economy.
Effects of Hurricane Harvey
In August 2017, Hurricane Harvey, a Category 4 hurricane, caused extensive and costly damage across Southeast Texas. The Houston and Beaumont areas received over 40 inches of rainfall, which resulted in catastrophic flooding and unprecedented damage to residences and businesses. We worked diligently throughout Hurricane Harvey and during its aftermath to ensure the safety of our employees and customers, as well as to continue to provide the financial services on which our customers greatly depend.
8
The operational impact to our Houston branches and infrastructure was minor. After Hurricane Harvey made landfall in Houston, we operated limited services in Houston from August 28, 2017 until August 31, 2017, which was largely due to the inability of our employees and customers to use the roadways or public transportation. Despite widespread flooding in Houston, none of our Houston branches flooded and all but one of our branches were open and operating at full capacity as of September 1, 2017. The remaining Houston branch reopened on September 6, 2017, after its electricity was restored.
Likewise, the operational impact to our Beaumont branches and infrastructure was minor and none of our Beaumont branches flooded. After Hurricane Harvey shifted course away from Houston and toward Beaumont, we operated limited services in Beaumont from August 29, 2017 until September 4, 2017. In Beaumont, all but one of our branches were open and operating at full capacity as of September 5, 2017. The remaining Beaumont branch reopened on September 11, 2017, after its utilities were restored.
Furthermore, our technology environment, bolstered by our business continuity plan, was fully operational and supported our customers and employees across all of our branches during Hurricane Harvey. Our call center, wire transfer, ATM and treasury services continued to provide telephone and electronic access for customers during the storm. During Hurricane Harvey, our business continuity plan worked as intended and is being reviewed for continued updates and improvements based on the experience.
We have begun to evaluate Hurricane Harvey's impact on our customers and our business, including our properties, assets and loan portfolios. Some of our customers were, and continue to be, adversely impacted by Hurricane Harvey. As part of the recovery process, we have contacted our customers to assist with their needs, as well as waived or refunded (i) late fees for loans with payments due from August 25, 2017 through September 10, 2017, and (ii) overdraft and ATM fees incurred from August 25, 2017 through September 10, 2017.
We have also engaged directly with customers through telephone calls to evaluate the impact of Hurricane Harvey on our consumer, real estate and business loan exposures. As of September 25, 2017, our real estate loan exposures in Houston and Beaumont consist primarily of commercial properties. Based on initial conversations with customers, we have determined that the majority of our significant commercial real estate customers are characterized as low risk (i.e., sustained minimal property damage). As of October 20, 2017, we do not anticipate that Hurricane Harvey will result in significant losses and as of October 20, 2017, only one loan relationship in the principal amount of approximately $400,000 appears to have significant uninsured damage and is being monitored by our loan officers and our Senior Credit Officer. Additionally, as of October 20, 2017, we have granted temporary payment deferrals on loans with an aggregate principal amount of approximately $50.1 million, largely to assist customers whose operations were impacted by Hurricane Harvey.
While we do not anticipate that Hurricane Harvey will have significant long-term effects on our business, financial condition or operations, we are unable to predict with certainty the short- and long-term impact that Hurricane Harvey may have on the markets in which we operate, including the impact on our customers and our loan and deposit activities and credit exposures. We will continue to monitor the residual effects of Hurricane Harvey on our business and customers.
Amendment and Restatement of Certificate of Formation
On September 19, 2017, we amended and restated our certificate of formation to, among other things, change our name from CBFH, Inc. to CBTX, Inc., increase the number of authorized common and preferred shares and reduce the par value of our common and preferred shares to $0.01 per share. For a detailed description of our amended and restated certificate of formation, see "Description of Capital Stock."
9
Second Amendment and Restatement of Bylaws
On October 10, 2017, we amended and restated our bylaws to provide that our board of directors will be divided into three classes commencing with our annual shareholders' meeting to be held in 2018, with members of each class serving a three-year term upon completion of a phase-in period. For a detailed description of the classification of our board of directors, see "Management" and "Description of Capital Stock—Classified Board of Directors."
Stock Split
On September 20, 2017, our board of directors approved a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each share owned as of the record date of September 30, 2017 in the form of a stock dividend that was distributed on October 13, 2017. The effect of the stock dividend has been retroactively applied to all periods presented in this prospectus.
Sale of Two Branches
Huffman Branch. On September 8, 2017, the Bank completed the sale of its branch located in Huffman, Texas, referred to as the Huffman Branch. Pursuant to a purchase and assumption agreement, the Bank sold certain assets associated with the Huffman Branch valued at approximately $1.4 million, other than loans, and the purchaser assumed approximately $15.3 million in deposits at the Huffman Branch. We believe that the sale of the Huffman Branch will reduce our noninterest expense going forward and we do not believe it will impact our liquidity.
Deweyville Branch. On September 14, 2017, we sold the real estate associated with our Deweyville, Texas branch, referred to as the Deweyville Branch, and we leased the facility back for approximately 120 days while we finalize the regulatory process for approval of closing this branch. We expect to complete the closing of the Deweyville Branch on December 18, 2017. The $4.7 million in deposits and $50,000 of loans at the Deweyville Branch will be transferred to one of our other nearby branch locations. We believe that the closure of the Deweyville Branch will reduce our noninterest expense going forward and we do not believe it will impact our liquidity.
We do not believe that the sale of our Huffman and Deweyville branches represents any strategic shift in our operations.
Preliminary Financial Results as of and for the Three and Nine Months Ended September 30, 2017
We expect to report net income in the range of $9.9 million to $10.2 million and diluted earnings per share in the range of $0.45 to $0.46 for the three months ended September 30, 2017 as compared to net income of $8.7 million and diluted earnings per share of $0.39 for the three months ended June 30, 2017 and net income of $6.8 million and diluted earnings per share of $0.31 for the three months ended September 30, 2016. We also expect to report net income in the range of $25.5 million to $25.8 million and diluted earnings per share in the range of $1.16 to $1.17 for the nine months ended September 30, 2017 as compared to net income of $19.7 million and diluted earnings per share of $0.88 for the nine months ended September 30, 2016. The increase in estimated net income and diluted earnings per share over the three and nine month periods ended September 30, 2017 is primarily attributable to (i) an increase in net interest income resulting primarily from an increase in earning assets, (ii) a negative loan loss provision of $1.7 million in the three-month period ended September 30, 2017 as a result of the payoff of $1.1 million of impaired loans and improvement of our credit metrics, (iii) gain on sales of assets of $100,000 (primarily related to the sales discussed in "Sale of Two Branches" above) and (iv) settlement of a legal matter that resulted in an estimated gain of $554,000. We expect the estimated net income range described above to result in a return on average
10
assets of 1.32% to 1.36% for the three months ended September 30, 2017 and 1.16% to 1.17% for the nine months ended September 30, 2017.
We expect to report that, as of September 30, 2017, net loans were $2.2 billion, representing a $33.5 million increase from September 30, 2016 and an $8.5 million increase from June 30, 2017. We expect to report that total deposits were $2.6 billion as of September 30, 2017, representing an increase of $25.4 million from September 30, 2016 and a $37.8 million increase from June 30, 2017. We expect to report that noninterest-bearing deposits were $1.1 billion as of September 30, 2017, representing an increase of $26.3 million from September 30, 2016 and a $20.9 million increase from June 30, 2017. Estimated increases in our net loans and total deposits were largely driven by organic growth.
We expect to report total shareholders' equity in the range of $381.0 million to $381.3 million as of September 30, 2017 as compared to $372.0 million as of June 30, 2017 and $357.6 million as of December 31, 2016. As a result, we expect to report book value per share in the range of $17.27 to $17.28 as of September 30, 2017 as compared to $16.86 as of June 30, 2017 and $16.21 as of December 31, 2016. Also, we expect to report tangible book value per share in the range of $13.28 to $13.29 as of September 30, 2017 as compared to $12.86 as of June 30, 2017 and $12.19 as of December 31, 2016. The estimated increases in our total shareholders' equity, book value per share and tangible book value per share are primarily attributable to the organic growth of retained earnings over the periods reflected. Tangible book value per share is a non-GAAP financial measure. The most directly comparable GAAP financial measure for tangible book value per share is book value per share. See "Non-GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures" for a description and reconciliation of actual and estimated tangible book value per share.
Our expected financial results for the three- and nine-month periods ended September 30, 2017 described above are preliminary estimates and subject to additional procedures, which we expect to complete after the completion of this offering. These additional procedures could result in material changes to our preliminary estimates during the course of our preparation of condensed consolidated financial statements as of and for the three and nine months ended September 30, 2017. The foregoing estimates constitute forward-looking statements and are subject to risks and uncertainties, including those described under "Risk Factors" in this prospectus. Accordingly, our condensed consolidated financial statements as of and for the three- and nine-month periods ended September 30, 2017 may not be consistent with the preliminary financial results described above. In addition, Grant Thornton LLP, our independent registered public accounting firm, has not performed review procedures over these preliminary financial results. See "Risk Factors—Risks Related to Our Business" and "Forward-Looking Statements."
Ours and the Bank's headquarters are located at 5999 Delaware Street, Beaumont, Texas 77706, and our telephone number is (409) 861-7200. The majority of our executives, including our Chairman, President and Chief Executive Officer, Robert R. Franklin, Jr., are located in our Houston office at 9 Greenway Plaza, Suite 110, Houston, Texas 77046, and the telephone number is (713) 210-7600. Our website is www.communitybankoftx.com. The information contained on or accessible from our website does not constitute a part of this prospectus and is not incorporated by reference herein.
11
Common stock offered by us |
2,400,000 shares of our common stock, par value $0.01 per share (or 2,760,000 shares if the underwriters exercise in full their option to purchase 360,000 additional shares). | |
Underwriters' option to purchase additional shares |
We have granted the underwriters an option to purchase up to an additional 360,000 shares within 30 days of the date of this prospectus. |
|
Common stock to be outstanding after this offering |
24,463,072 shares (or 24,823,072 shares if the underwriters exercise in full their option to purchase additional shares). |
|
Use of proceeds |
Assuming an initial public offering price of $25.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus, we estimate that the net proceeds to us from this offering, after deducting estimated underwriting discounts but before payment of estimated offering expenses payable by us, will be approximately $55.8 million (or approximately $64.2 million if the underwriters exercise in full their option to purchase additional shares). We intend to use the net proceeds from this offering to support our organic growth and for general corporate purposes, including maintenance of our required regulatory capital, and potential future acquisition opportunities. See "Use of Proceeds" on page 54 of this prospectus. |
|
Dividend policy |
Holders of our common stock are only entitled to receive dividends when, as and if declared by our board of directors out of funds legally available for dividends. We currently expect to pay (when, as and if declared by our board of directors) regular quarterly cash dividends of $0.05 per share. Our ability to pay dividends to our shareholders in the future will depend on regulatory restrictions, liquidity and capital requirements, our earnings and financial condition, the general economic climate, contractual restrictions, our ability to service any equity or debt obligations senior to our common stock and other factors deemed relevant by our board of directors. For additional information, see "Dividend Policy" on page 55 of this prospectus. |
12
Directed share program |
At our request, the underwriters have reserved for sale, at the initial public offering price, up to 5.0% of the shares of our common stock pursuant to this prospectus for sale to certain of our directors, executive officers, employees, business associates and related persons who have expressed an interest in purchasing our common stock in this offering. We do not know if these persons will choose to purchase all or any portion of the reserved shares, but any purchases they do make will reduce the number of shares available to the general public. See "Underwriting" on page 177 of this prospectus. |
|
Nasdaq Global Select Market listing |
We have applied to list our common stock on the Nasdaq Global Select Market under the trading symbol "CBTX." |
|
Risk factors |
Investing in our common stock involves certain risks. See "Risk Factors," beginning on page 18, for a discussion of factors that you should carefully consider before investing in our common stock. |
Except as otherwise indicated, all information in this prospectus:
- •
- gives effect to a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each
share owned as of the record date of September 30, 2017 in the form of a stock dividend that was distributed on October 13, 2017;
- •
- assumes no exercise by the underwriters of their option to purchase 360,000 additional shares of our common stock;
- •
- does not attribute to any director, executive officer or principal shareholder any purchase of shares of our common stock in the offering,
including through the directed share program described in "Underwriting—Directed Share Program;"
- •
- excludes 295,314 shares of our common stock issuable upon the exercise of outstanding stock options with a weighted exercise price of $14.15
per share, as of June 30, 2017;
- •
- excludes shares of common stock that may be granted under the CBTX, Inc. 2017 Omnibus Incentive Plan in connection with this offering,
including grants of 155,110 shares of restricted stock to be effective when the registration statement of which this prospectus forms a part is declared effective by the SEC; and
- •
- assumes an initial public offering price of $25.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus.
13
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
You should read the following selected historical consolidated financial data in conjunction with our consolidated financial statements and related notes and the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Capitalization" included elsewhere in this prospectus. The following tables set forth selected historical consolidated financial data (i) as of and for the six months ended June 30, 2017 and 2016 and (ii) as of and for the years ended December 31, 2016, 2015, 2014, 2013 and 2012. Selected financial data as of and for the years ended December 31, 2016 and 2015, have been derived from our audited financial statements included elsewhere in this prospectus. We have derived the selected financial data as of and for the years ended December 31, 2014, 2013 and 2012 from our audited financial statements not included in this prospectus. We have derived selected financial data as of June 30, 2016 from our unaudited financial statements not included in this prospectus. Selected financial data as of and for the six months ended June 30, 2017, has been derived from our unaudited financial statements included elsewhere in this prospectus and has not been audited but, in the opinion of our management, contain all adjustments (consisting of only normal or recurring adjustments) necessary to present fairly in all material respects our financial position and results of operations for the period in accordance with generally accepted accounting principles, or GAAP. Our historical results are not necessarily indicative of any future period. The performance, asset quality and capital ratios are unaudited and derived from our audited and unaudited financial statements as of and for the periods presented. Average balances have been calculated using daily averages. The information presented in the table below has been adjusted to give effect to a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each share owned as of the record date of September 30, 2017, in the form of a stock dividend that was distributed on October 13, 2017. The effect of the stock split on outstanding share and per share figures has been retroactively applied to all periods presented.
| |
As of and for the Six Months Ended June 30, |
As of and for the Years Ended December 31, | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands, except share and per share data) |
2017 | 2016 | 2016 | 2015 | 2014 | 2013 | 2012 (as restated)(7) |
|||||||||||||||
Balance Sheet Data: |
||||||||||||||||||||||
Cash and cash equivalents |
$ | 307,173 | $ | 336,014 | $ | 382,103 | $ | 434,901 | $ | 490,748 | $ | 424,544 | $ | 333,752 | ||||||||
Securities |
220,330 | 170,656 | 205,978 | 145,789 | 96,052 | 102,228 | 87,188 | |||||||||||||||
Total loans(1) |
2,192,443 | 2,153,091 | 2,154,885 | 2,092,010 | 1,876,593 | 1,757,431 | 1,158,897 | |||||||||||||||
Allowance for loan losses |
25,187 | 26,716 | 25,006 | 25,315 | 24,952 | 23,843 | 17,498 | |||||||||||||||
Goodwill and intangible assets, net |
88,248 | 89,314 | 88,741 | 89,829 | 67,952 | 69,274 | 58,651 | |||||||||||||||
Total assets |
2,940,877 | 2,872,687 | 2,951,522 | 2,882,625 | 2,628,587 | 2,450,865 | 1,711,467 | |||||||||||||||
Noninterest-bearing deposits |
1,030,865 | 1,047,606 | 1,025,425 | 1,053,957 | 974,571 | 824,870 | 566,680 | |||||||||||||||
Interest-bearing deposits |
1,485,919 | 1,420,990 | 1,515,335 | 1,429,409 | 1,294,482 | 1,290,357 | 900,861 | |||||||||||||||
Total deposits |
2,516,784 | 2,468,596 | 2,540,760 | 2,483,366 | 2,269,053 | 2,115,227 | 1,467,541 | |||||||||||||||
Total shareholders' equity |
371,964 | 347,316 | 357,637 | 344,313 | 329,252 | 311,139 | 222,901 | |||||||||||||||
Income Statement Data: |
||||||||||||||||||||||
Interest income |
$ | 56,724 | $ | 54,245 | $ | 109,951 | $ | 105,525 | $ | 96,458 | $ | 80,049 | $ | 64,391 | ||||||||
Interest expense |
4,366 | 3,983 | 8,405 | 7,654 | 6,371 | 6,414 | 5,707 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Net interest income |
52,358 | 50,262 | 101,546 | 97,871 | 90,087 | 73,635 | 58,684 | |||||||||||||||
Provision for loan losses |
266 | 2,700 | 4,575 | 6,950 | 3,766 | 10,255 | 5,719 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Net interest income after provision for loan losses |
52,092 | 47,562 | 96,971 | 90,921 | 86,321 | 63,380 | 52,965 | |||||||||||||||
Noninterest income |
6,974 | 7,798 | 15,749 | 14,967 | 13,356 | 11,716 | 10,265 | |||||||||||||||
Noninterest expense |
37,286 | 36,834 | 73,502 | 70,961 | 66,359 | 56,508 | 46,772 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Income before income tax expense |
21,780 | 18,526 | 39,218 | 34,927 | 33,318 | 18,588 | 16,458 | |||||||||||||||
Income tax expense |
6,213 | 5,656 | 12,010 | 10,791 | 10,476 | 5,685 | 5,017 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Net income |
$ | 15,567 | $ | 12,870 | $ | 27,208 | $ | 24,136 | $ | 22,842 | $ | 12,903 | $ | 11,441 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Share and Per Share Data: |
||||||||||||||||||||||
Earnings per share—Basic |
$ | 0.71 | $ | 0.58 | $ | 1.23 | $ | 1.07 | $ | 1.01 | $ | 0.69 | $ | 0.73 | ||||||||
Earnings per share—Diluted |
0.70 | 0.58 | 1.22 | 1.06 | 1.00 | 0.68 | 0.73 | |||||||||||||||
Dividends per share |
0.10 | 0.10 | 0.20 | 0.20 | 0.20 | 0.20 | 0.20 | |||||||||||||||
Book value per share(2) |
16.86 | 15.88 | 16.21 | 15.44 | 14.61 | 13.80 | 14.31 | |||||||||||||||
Tangible book value per share(3) |
12.86 | 11.80 | 12.19 | 11.41 | 11.60 | 10.73 | 10.55 | |||||||||||||||
14
| |
As of and for the Six Months Ended June 30, |
As of and for the Years Ended December 31, | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands, except share and per share data) |
2017 | 2016 | 2016 | 2015 | 2014 | 2013 | 2012 (as restated)(7) |
|||||||||||||||
Weighted average common shares outstanding—Basic |
22,062,210 | 22,166,844 | 22,048,724 | 22,462,176 | 22,529,778 | 18,783,146 | 15,592,950 | |||||||||||||||
Weighted average common shares outstanding—Diluted |
22,148,736 | 22,312,750 | 22,235,056 | 22,675,046 | 22,764,994 | 19,019,064 | 15,592,950 | |||||||||||||||
Common shares outstanding at end of period |
22,063,072 | 21,870,418 | 22,062,072 | 22,303,474 | 22,533,930 | 22,543,954 | 15,575,418 | |||||||||||||||
Performance Ratios: |
||||||||||||||||||||||
Return on average assets(8) |
1.08 | % | 0.92 | % | 0.94 | % | 0.85 | % | 0.90 | % | 0.65 | % | 0.74 | % | ||||||||
Return on average shareholders' equity(8) |
8.58 | % | 7.50 | % | 7.79 | % | 7.16 | % | 7.07 | % | 4.86 | % | 5.21 | % | ||||||||
Net interest margin(4) |
4.05 | % | 4.02 | % | 3.96 | % | 3.85 | % | 3.92 | % | 4.02 | % | 4.31 | % | ||||||||
Noninterest expense to average assets(8) |
2.58 | % | 2.62 | % | 2.55 | % | 2.49 | % | 2.61 | % | 2.83 | % | 3.02 | % | ||||||||
Efficiency ratio(5) |
62.84 | % | 63.44 | % | 62.66 | % | 62.89 | % | 64.15 | % | 66.21 | % | 67.83 | % | ||||||||
Selected Ratios: |
||||||||||||||||||||||
Loans to deposits |
87.11 | % | 87.22 | % | 84.81 | % | 84.24 | % | 82.70 | % | 83.08 | % | 79.36 | % | ||||||||
Noninterest-bearing deposits to total deposits |
40.96 | % | 42.44 | % | 40.36 | % | 42.44 | % | 42.95 | % | 39.00 | % | 38.61 | % | ||||||||
Cost of deposits |
0.30 | % | 0.27 | % | 0.28 | % | 0.26 | % | 0.28 | % | 0.35 | % | 0.42 | % | ||||||||
Credit Quality Ratios: |
||||||||||||||||||||||
Nonperforming assets to total assets |
0.33 | % | 0.48 | % | 0.27 | % | 0.52 | % | 0.93 | % | 0.65 | % | 0.94 | % | ||||||||
Nonperforming loans to total loans |
0.38 | % | 0.53 | % | 0.29 | % | 0.66 | % | 1.23 | % | 0.73 | % | 1.12 | % | ||||||||
Allowance for loan losses to nonperforming loans |
305.11 | % | 232.82 | % | 400.80 | % | 183.28 | % | 107.76 | % | 185.59 | % | 133.93 | % | ||||||||
Allowance for loan losses to total loans |
1.15 | % | 1.24 | % | 1.16 | % | 1.21 | % | 1.33 | % | 1.36 | % | 1.51 | % | ||||||||
Net charge-offs to average loans(8) |
0.01 | % | 0.12 | % | 0.23 | % | 0.32 | % | 0.15 | % | 0.28 | % | 0.33 | % | ||||||||
Capital Ratios: |
||||||||||||||||||||||
Total shareholders' equity to total assets |
12.65 | % | 12.09 | % | 12.12 | % | 11.94 | % | 12.53 | % | 12.70 | % | 13.02 | % | ||||||||
Tangible equity to tangible assets(6) |
9.95 | % | 9.27 | % | 9.39 | % | 9.11 | % | 10.20 | % | 10.16 | % | 9.94 | % | ||||||||
Common equity tier 1 capital ratio |
12.00 | % | 10.68 | % | 11.52 | % | 10.89 | % | N/A | N/A | N/A | |||||||||||
Tier 1 leverage ratio |
10.39 | % | 9.71 | % | 9.78 | % | 9.34 | % | 10.71 | % | 10.72 | % | 11.00 | % | ||||||||
Tier 1 risk-based capital ratio |
12.26 | % | 10.94 | % | 11.78 | % | 11.16 | % | 13.41 | % | 13.37 | % | 13.79 | % | ||||||||
Total risk-based capital ratio |
13.33 | % | 12.06 | % | 12.85 | % | 12.24 | % | 14.66 | % | 14.62 | % | 15.03 | % | ||||||||
- (1)
- Total
loans does not include loans held for sale of $559 and $1,971 on June 30, 2017 and June 30, 2016, respectively, and $613, $1,562, $620, $1,155,
and $5,723, at December 31, 2016, 2015, 2014, 2013 and 2012, respectively. Also, total loans is net of deferred fees and unearned discounts of $4,436 and $5,580 at June 30, 2017 and
2016, respectively, and $4,548, $5,680, $3,124, $1,240, and $594 at December 31, 2016, 2015, 2014, 2013 and 2012, respectively.
- (2)
- We
calculate book value per share as total shareholders' equity at the end of the relevant period divided by the outstanding number of shares of our common stock at
the end of the relevant period.
- (3)
- Tangible
book value per share is a non-GAAP financial measure. The most directly comparable GAAP financial measure is book value per share. We calculate tangible
book value per share as total shareholders' equity, less goodwill and other intangible assets, net of accumulated amortization at the end of the relevant period, divided by the outstanding number of
shares of our common stock at the end of the relevant period. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption
"Non-GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures."
- (4)
- Net
interest margin is shown on a fully taxable equivalent basis.
- (5)
- Efficiency
ratio represents noninterest expense divided by the sum of net interest income and noninterest income.
- (6)
- Tangible
equity to tangible assets is a non-GAAP financial measure. The most directly comparable GAAP financial measure is total shareholders' equity to total
assets. We calculate tangible equity as total shareholders' equity, less goodwill and other intangible assets, net of accumulated amortization, and we calculate tangible assets as total assets, less
goodwill and other intangible assets, net of accumulated amortization. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption
"Non-GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures."
- (7)
- The
financial information as of and for the year ended December 31, 2012 included in this prospectus derived from our audited financial statements not
included herein has been restated. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Restatement of 2012 Financial Statements."
- (8)
- The ratio calculations as of and for the six months ended June 30, 2017 and 2016 represent the annualized calculations.
15
Non-GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Our accounting and reporting policies conform to GAAP and the prevailing practices in the banking industry. However, we also evaluate our performance based on certain additional financial measures discussed in this prospectus as being non-GAAP financial measures. We classify a financial measure as a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are not included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios or statistical measures calculated using exclusively financial measures calculated in accordance with GAAP.
The non-GAAP financial measures that we discuss in this prospectus should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in this prospectus may differ from that of other companies reporting measures with similar names. It is important to understand how other banking organizations calculate their financial measures with names similar to the non-GAAP financial measures we have discussed in this prospectus when comparing such non-GAAP financial measures.
Tangible Book Value Per Share. We calculate (1) tangible equity as total shareholders' equity, less goodwill and other intangible assets, net of accumulated amortization at the end of the relevant period, and (2) tangible book value per share as tangible equity divided by shares of common stock outstanding at the end of the relevant period. The most directly comparable GAAP financial measure for tangible book value per share is book value per share.
We believe that the tangible book value per share measure is important to many investors in the marketplace who are interested in changes from period to period in book value per share exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing total book value while not increasing our tangible book value.
The book value per share and tangible book value per share have been adjusted in the table below to give effect to a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each share owned as of the record date of September 30, 2017, in the form of a stock dividend that was distributed on October 13, 2017. The effect of the stock split on outstanding share and per share figures has been retroactively applied to all periods presented.
The following tables reconcile, as of the dates set forth below, total shareholders' equity to tangible equity and presents tangible book value per share compared to book value per share:
| |
As of September 30, 2017(1) | ||||||
|---|---|---|---|---|---|---|---|
(Dollars in thousands, except share data)
|
Low | High | |||||
Tangible Equity |
|||||||
Total shareholders' equity |
$ | 380,974 | $ | 381,274 | |||
Adjustments: |
|||||||
Goodwill |
80,950 | 80,950 | |||||
Other intangibles |
7,031 | 7,031 | |||||
| | | | | | | | |
Tangible equity |
$ | 292,993 | $ | 293,293 | |||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Common shares outstanding(2) |
22,063,072 | 22,063,072 | |||||
Book value per share |
$ | 17.27 | $ | 17.28 | |||
Tangible Book Value Per Share |
$ | 13.28 | $ | 13.29 | |||
- (1)
- Figures included in this reconciliation are preliminary estimates and subject to additional procedures, which we expect to complete after the completion of this offering. These additional procedures could result in material changes to our
16
preliminary estimates. See "Prospectus Summary—Recent Developments—Preliminary Financial Results as of and for the Three and Nine Months Ended September 30, 2017" for additional information.
- (2)
- Excludes the dilutive effect, if any, of 315,154 shares of common stock issuable upon exercise of outstanding stock options as of September 30, 2017.
| |
As of June 30, | As of December 31, | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands, except per share data) |
2017 | 2016 | 2016 | 2015 | 2014 | 2013 | 2012 (as restated)(2) |
|||||||||||||||
Tangible Equity |
||||||||||||||||||||||
Total shareholders' equity |
$ | 371,964 | $ | 347,316 | $ | 357,637 | $ | 344,313 | $ | 329,252 | $ | 311,139 | $ | 222,901 | ||||||||
Adjustments: |
||||||||||||||||||||||
Goodwill |
80,950 | 80,950 | 80,950 | 80,950 | 59,049 | 59,049 | 57,667 | |||||||||||||||
Other intangibles |
7,298 | 8,364 | 7,791 | 8,879 | 8,903 | 10,225 | 984 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Tangible equity |
$ | 283,716 | $ | 258,002 | $ | 268,896 | $ | 254,484 | $ | 261,300 | $ | 241,865 | $ | 164,250 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Common shares outstanding(1) |
22,063,072 | 21,870,418 | 22,062,072 | 22,303,474 | 22,533,930 | 22,543,954 | 15,575,418 | |||||||||||||||
Book value per share |
$ | 16.86 | $ | 15.88 | $ | 16.21 | $ | 15.44 | $ | 14.61 | $ | 13.80 | $ | 14.31 | ||||||||
Tangible Book Value per Share |
$ | 12.86 | $ | 11.80 | $ | 12.19 | $ | 11.41 | $ | 11.60 | $ | 10.73 | $ | 10.55 | ||||||||
- (1)
- Excludes
the dilutive effect, if any, of 295,314 and 445,030 shares of common stock issuable upon exercise of outstanding stock options as of June 30, 2017
and 2016, respectively, and 248,314, 647,074, 575,326, 593,812 and 0 shares of common stock issuable upon exercise of outstanding stock options as of December 31, 2016, 2015, 2014, 2013 and
2012, respectively.
- (2)
- The financial information as of and for the year ended December 31, 2012 included in this prospectus derived from our audited financial statements not included herein has been restated. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Restatement of 2012 Financial Statements."
Tangible Equity to Tangible Assets. We calculate tangible equity as described above, and tangible assets as total assets, less goodwill and other intangible assets, net of accumulated amortization. The most directly comparable GAAP financial measure for tangible equity to tangible assets is total shareholders' equity to total assets.
We believe that this measure is important to many investors in the marketplace who are interested in the relative changes from period to period of tangible equity to tangible assets, each exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing both total shareholders' equity and assets while not increasing our tangible equity or tangible assets.
The following tables reconcile, as of the dates set forth below, total shareholders' equity to tangible equity and total assets to tangible assets, and presented tangible equity to tangible assets compared to total shareholders equity to total assets.
| |
As of June 30, | As of December 31, | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands)
|
2017 | 2016 | 2016 | 2015 | 2014 | 2013 | 2012 (as restated)(1) |
|||||||||||||||
Tangible Equity |
||||||||||||||||||||||
Total shareholders' equity |
$ | 371,964 | $ | 347,316 | $ | 357,637 | $ | 344,313 | $ | 329,252 | $ | 311,139 | $ | 222,901 | ||||||||
Adjustments: |
||||||||||||||||||||||
Goodwill |
80,950 | 80,950 | 80,950 | 80,950 | 59,049 | 59,049 | 57,667 | |||||||||||||||
Other intangibles |
7,298 | 8,364 | 7,791 | 8,879 | 8,903 | 10,225 | 984 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Tangible equity |
$ | 283,716 | $ | 258,002 | $ | 268,896 | $ | 254,484 | $ | 261,300 | $ | 241,865 | $ | 164,250 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Tangible Assets |
||||||||||||||||||||||
Total assets |
$ | 2,940,877 | $ | 2,872,687 | $ | 2,951,522 | $ | 2,882,625 | $ | 2,628,587 | $ | 2,450,865 | $ | 1,711,467 | ||||||||
Adjustments |
||||||||||||||||||||||
Goodwill |
80,950 | 80,950 | 80,950 | 80,950 | 59,049 | 59,049 | 57,667 | |||||||||||||||
Other intangibles |
7,298 | 8,364 | 7,791 | 8,879 | 8,903 | 10,225 | 984 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Tangible assets |
$ | 2,852,629 | $ | 2,783,373 | $ | 2,862,781 | $ | 2,792,796 | $ | 2,560,635 | $ | 2,381,591 | $ | 1,652,816 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Tangible Equity to Tangible Assets |
9.95 | % | 9.27 | % | 9.39 | % | 9.11 | % | 10.20 | % | 10.16 | % | 9.94 | % | ||||||||
Total Shareholders' Equity to Total Assets |
12.65 | % | 12.09 | % | 12.12 | % | 11.94 | % | 12.53 | % | 12.70 | % | 13.02 | % | ||||||||
- (1)
- The financial information as of and for the year ended December 31, 2012 included in this prospectus derived from our audited financial statements not included herein has been restated. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Restatement of 2012 Financial Statements."
17
Investing in our common stock involves a significant degree of risk. You should carefully consider the following risk factors, in addition to the other information contained in this prospectus, including our consolidated financial statements and related notes, before deciding to invest in our common stock. Any of the following risks could have a material adverse effect on our business, financial condition, results of operations and future prospects. As a result, the trading price of our common stock could decline, and you could lose all or part of your investment. Some statements in this prospectus, including statements in the following risk factors section, constitute forward-looking statements. Please refer to "Cautionary Note Regarding Forward-Looking Statements."
Risks Related to Our Business
Hurricanes or other adverse weather events in Texas can have an adverse impact on our business, financial condition and operations.
Hurricanes, tropical storms, natural disasters and other adverse weather events can have an adverse impact on our business, financial condition and operations, cause widespread property damage and have the potential to significantly depress the local economies in which we operate. We operate banking locations throughout Beaumont and Houston, areas which are susceptible to hurricanes, tropical storms and other natural disasters and adverse weather conditions. For example, in late August 2017, Hurricane Harvey, a Category 4 hurricane, caused extensive and costly damage across Southeast Texas. The Houston and the Beaumont areas received over 40 inches of rainfall, which resulted in catastrophic flooding and unprecedented damage to residences and businesses. Although based on our initial assessment we do not believe that Hurricane Harvey will have significant long-term effects on our business, financial condition or operations, we are unable to predict with certainty the full impact of the storm on the markets in which we operate, including any adverse impact on our customers and our loan and deposit activities and credit exposures.
Similar future adverse weather events in Texas could potentially result in extensive and costly property damage to businesses and residences, force the relocation of residents and significantly disrupt economic activity in the region. We cannot predict the extent of damage that may result from such adverse weather events, which will depend on a variety of factors that are beyond our control, including, but not limited to, the severity and duration of the event, the timing and level of government responsiveness and the pace of economic recovery. If a significant adverse weather event were to occur, it could have a materially adverse impact on our financial condition, results of operations and our business, as well as potentially increase our exposure to credit and liquidity risks.
Our primary markets are susceptible to natural disasters and other catastrophes that could negatively impact the economies of our markets, our operations or our customers, any of which could have a material adverse effect on our business, financial condition and results of operations.
A substantial majority of our business is generated from our Beaumont and Houston markets, which are susceptible to damage by hurricanes, such as Hurricane Harvey and Hurricane Ike, which struck the Gulf Coast in 2017 and 2008, respectively. We are also subject to tornadoes, floods, droughts and other natural disasters and adverse weather. In addition to natural disasters, man-made events, such as acts of terror and governmental responses to acts of terror, malfunctions of the electronic grid and other infrastructure breakdowns, could adversely affect economic conditions in our primary markets. These catastrophic events can disrupt our operations, cause widespread property damage, severely depress the local economies in which we operate and adversely affect our customers. If the economies in our primary markets experience an overall decline as a result of a catastrophic event, demand for loans and our other products and services could decline. In addition, the rates of delinquencies, foreclosures, bankruptcies and losses on our loan portfolios may increase substantially
18
after events such as hurricanes, as uninsured property losses, interruptions of our 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 our loans could be materially and adversely affected by a catastrophic event. A natural disaster or other catastrophic event could, therefore, result in decreased revenue and loan losses that have a material adverse effect on our business, financial condition and results of operations.
Our business is concentrated in, and largely dependent upon, the continued growth and welfare of our primary markets of Beaumont and Houston, and adverse economic conditions in these markets could negatively impact our operations and customers.
Our business, financial condition and results of operations are affected by changes in the economic conditions of our primary markets of Beaumont and Houston. Our success depends to a significant extent upon the business activity, population, income levels, employment trends, deposits and real estate activity in our primary markets. Economic conditions within our primary markets, and the state of Texas in general, are influenced by the energy sector generally and the price of oil and gas specifically. Although our customers' business and financial interests may extend well beyond our primary markets, adverse conditions that affect our primary markets, including future declines in oil or real estate prices, could reduce our growth rate, affect the ability of our customers to repay their loans, affect the value of collateral underlying our loans, affect our ability to attract deposits and generally affect our business, financial condition, results of operations and future prospects. Due to our geographic concentration within our primary markets, we may be less able than other larger regional or national financial institutions to diversify our credit risks across multiple markets. See "Risk Factors—Risks Related to Our Business—Our primary markets are susceptible to natural disasters and other catastrophes that could negatively impact the economies of our markets, our operations or our customers, any of which could have a material adverse effect on our business, financial condition and results of operations."
We may not be able to implement our expansion strategy, which may adversely affect our ability to maintain our historical earnings trends.
Our expansion strategy focuses on organic growth, supplemented by strategic acquisitions and expansion of the Bank's banking location network, or de novo branching. We may not be able to execute on aspects of our expansion strategy, which may impair our ability to sustain our historical rate of growth or prevent us from growing at all. More specifically, we may not be able to generate sufficient new loans and deposits within acceptable risk and expense tolerances, obtain the personnel or funding necessary for additional growth or find suitable acquisition candidates. Various factors, such as economic conditions and competition with other financial institutions, may impede or prohibit the growth of our operations, the opening of new banking locations and the consummation of acquisitions. Further, we may be unable to attract and retain experienced bankers, which could adversely affect our growth. The success of our strategy also depends on our ability to effectively manage growth, which is dependent upon a number of factors, including our ability to adapt our credit, operational, technology and governance infrastructure to accommodate expanded operations. If we fail to implement one or more aspects of our strategy, we may be unable to maintain our historical earnings trends, which could have a material adverse effect on our business, financial condition and results of operations.
We may not be able to manage the risks associated with our anticipated growth and expansion through de novo branching, which could have a material adverse effect on our business, financial condition and results of operations.
Our business strategy includes evaluating strategic opportunities to grow through de novo branching, and we believe that banking location expansion has been meaningful to our growth since
19
inception. De novo branching 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 successfully integrate and promote our corporate culture; poor market reception for de novo banking locations established in markets where we do not have a preexisting reputation; challenges posed by local economic conditions; challenges associated with securing attractive locations at a reasonable cost; and the additional strain on management resources and internal systems and controls. Failure to adequately manage the risks associated with our anticipated growth through de novo branching could have a material adverse effect on our business, financial condition and results of operations.
We rely heavily on our executive management team and other key employees, and we could be adversely affected by the unexpected loss of their services.
Our success depends in large part on the performance of our executive management team and other key personnel, as well as on our 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 key personnel with the combination of skills, attributes and business relationships required to execute our business plan may be lengthy. We may not be successful in retaining our key employees, and the unexpected loss of services of one or more of our key personnel could have an adverse effect on our business because of their skills, knowledge of and business relationships within our primary markets, years of industry experience and the difficulty of promptly finding qualified replacement personnel. If the services of any of our key personnel should become unavailable for any reason, we may not be able to identify and hire qualified persons on terms acceptable to us, or at all, which could have a material adverse effect on our business, financial condition, results of operations and future prospects.
We may not be able to adequately measure and limit our 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 our 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. Many of our loans are made to small to medium-sized businesses that may be less able to withstand competitive, economic and financial pressures than larger borrowers. Our risk management practices, such as monitoring the concentration of our loans within specific industries and our credit approval practices, may not adequately reduce credit risk, and our 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. A failure to effectively measure and limit the credit risk associated with our loan portfolio could lead to unexpected losses and have a material adverse effect on our business, financial condition and results of operations.
Our allowance for loan losses may prove to be insufficient to absorb potential losses in our loan portfolio, which may adversely affect our business, financial condition and results of operations.
We maintain an allowance for loan losses that represents management's judgment of probable losses and risks inherent in our loan portfolio. As of June 30, 2017, our allowance for loan losses totaled $25.2 million, which represents approximately 1.15% of our total loans. The level of the allowance reflects management's continuing evaluation of general economic conditions, diversification and seasoning of the loan portfolio, historic loss experience, identified credit problems, delinquency levels and adequacy of collateral. The determination of the appropriate level of the allowance for loan losses is inherently highly subjective and requires us to make significant estimates of and assumptions regarding current credit risks and future trends, all of which may undergo material changes. Inaccurate
20
management assumptions, deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification or deterioration of additional problem loans, acquisition of problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan losses.
In addition, our regulators, as an integral part of their periodic examination, review our methodology for calculating, and the adequacy of, our allowance for loan losses and may direct us 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 allowance for loan losses, we may need additional provisions for loan losses to restore the adequacy of our allowance for loan losses. Finally, the measure of our allowance for loan losses is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board, or FASB, recently issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become applicable to us on January 1, 2020, though we may choose, or may be encouraged by our regulators, to adopt CECL on January 1, 2019. CECL will require financial institutions to estimate and develop a provision for credit losses at origination for the lifetime of the loan, as opposed to reserving for incurred or probable losses up to the balance sheet date. Under the CECL model, credit deterioration would be reflected in the income statement in the period of origination or acquisition of the loan, with changes in expected credit losses due to further credit deterioration or improvement reflected in the periods in which the expectation changes. Accordingly, implementation of the CECL model will change our current method of providing allowances for loan losses, which would likely require us to increase our allowance for loan losses. Moreover, the CECL model likely would create more volatility in our level of allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
The amount of nonperforming and classified assets may increase significantly, resulting in additional losses, costs and expenses that will negatively affect our operations and financial condition.
At June 30, 2017, we had a total of approximately $9.7 million of nonperforming assets, or approximately 0.33% of total assets. Total loans classified as "substandard," "doubtful" or "loss" as of June 30, 2017 were approximately $55.6 million, or approximately 1.89% of total assets.
An asset is generally considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified must have a well-defined weakness(es) that jeopardize the liquidation of the debt. "Substandard" assets include those characterized by the "distinct possibility" that we will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard" with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.
Should the amount of nonperforming assets increase in the future, we may incur losses, and the costs and expenses to maintain such assets likewise can be expected to increase and potentially negatively affect earnings. An additional increase in losses due to such assets could have a material adverse effect on our business, financial condition and results of operations. Such effects may be particularly pronounced in a market of reduced real estate values and excess inventory.
21
Nonperforming assets take significant time and resources to resolve and adversely affect our results of operations and financial condition.
Nonperforming assets adversely affect our net income in various ways. We generally do not record interest income on other owned real estate, or OREO, or on nonperforming loans, thereby adversely affecting our income and increasing loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss. An increase in the level of nonperforming assets increases our risk profile and may impact the capital levels regulators believe are appropriate in light of the ensuing risk profile. While we seek 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, whether or not due to economic and market conditions beyond our control, could have a material effect on our business, financial condition and results of operations. In addition, 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. We may not experience future increases in the value of nonperforming assets.
We are subject to interest rate risk and fluctuations in interest rates may adversely affect our earnings.
The majority of our banking assets and liabilities are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, our earnings are significantly dependent on our net interest income, the principal component of our earnings, which is the difference between interest earned by us from our interest-earning assets, such as loans and investment securities, and interest paid by us on our interest-bearing liabilities, such as deposits and borrowings. We expect that we will periodically experience "gaps" in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this "gap" will negatively impact our earnings. The impact on earnings is more adverse when the slope of the yield curve flattens, that is, when short-term interest rates increase more than long-term interest rates or when long-term interest rates decrease more than short-term interest rates. Many factors impact interest rates, including governmental monetary policies, inflation, recession, changes in unemployment, the money supply and international economic weakness and disorder and instability in domestic and foreign financial markets. Our interest rate sensitivity profile was asset sensitive as of June 30, 2017, meaning that we estimate our net interest income would increase more from rising interest rates than from falling interest rates.
Interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default and could result in a decrease in the demand for loans. At the same time, the marketability of the property securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as borrowers refinance their loans at lower rates. In addition, in a low interest rate environment, loan customers often pursue long-term fixed rate credits, which could adversely affect our earnings and net interest margin if rates increase. Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have a material adverse effect on our results of operations and cash flows. Further, when we place a loan on nonaccrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income. At the same time, we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming assets would have an adverse impact on net interest income. If short-term interest rates continue to remain at their historically low levels for a prolonged period, and assuming longer-term interest rates
22
fall further, we could experience net interest margin compression as our interest-earning assets would continue to reprice downward while our interest-bearing liability rates could fail to decline in tandem. Such an occurrence would have an adverse effect on our net interest income and could have a material adverse effect on our business, financial condition and results of operations.
We may not be able to overcome the integration and other risks associated with acquisitions, which could have a material adverse effect on our ability to implement our business strategy.
Although we plan to continue to grow our business organically and through de novo branching, we also intend to pursue acquisition opportunities that we believe complement our activities and have the ability to enhance our profitability and provide attractive risk-adjusted returns. Our acquisition activities could be material to our business and involve a number of risks, including the following:
- •
- intense competition from other banking organizations and other acquirers for potential merger candidates;
- •
- market pricing for desirable acquisitions resulting in returns that are less attractive than we have traditionally sought to achieve;
- •
- incurring time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions, resulting
in our attention being diverted from the operation of our existing business;
- •
- using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or
assets;
- •
- failure to achieve expected revenues, earnings or synergies from an acquisition;
- •
- potential exposure to unknown or contingent liabilities of banks and businesses we acquire, including compliance and regulatory issues;
- •
- the time and expense required to integrate the operations and personnel of the combined businesses;
- •
- experiencing higher operating expenses relative to operating income from the new operations and the failure to achieve expected cost savings;
- •
- losing key employees and customers;
- •
- reputational issues if the target's management does not align with our culture and values;
- •
- significant problems relating to the conversion of the financial and customer data of the target;
- •
- integration of acquired customers into our financial and customer product systems;
- •
- risks of impairment to goodwill; or
- •
- regulatory timeframes for review of applications may limit the number and frequency of transactions we may be able to consummate.
Depending on the condition of any institution or assets or liabilities that we may acquire, that acquisition may, at least in the near term, adversely affect our capital and earnings and, if not successfully integrated with our organization, may continue to have such effects over a longer period. We may not be successful in overcoming these risks or any other problems encountered in connection with pending or potential acquisitions, and any acquisition we may consider will be subject to prior regulatory approval. Our inability to overcome these risks could have an adverse effect on our ability to implement our business strategy, which, in turn, could have a material adverse effect on our business, financial condition and results of operations.
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A component of our strategy is a focus on decision-making authority at the branch and market level, and our business, financial condition, results of operations and prospects could be adversely affected if our local teams do not follow our internal policies or are negligent in their decision-making.
In order to be able to provide the responsive and individualized customer service that distinguishes us from competitors and in order to attract and retain management talent, we empower our local management teams to make certain business decisions on the local level. Certain operational and lending authorities are assigned to managers and their banking teams based on their experience, with all loan relationships in excess of internal specified maximums being reviewed by the Bank's Directors Loan Committee, comprised of senior management of the Bank, or the Bank's board of directors, as the case may be. Our local management teams may not follow our internal procedures or otherwise act in our best interests with respect to their decision-making. A failure of our employees to follow our internal policies, or actions taken by our employees that are negligent or not in our best interests could have a material adverse effect on our business, financial condition and results of operations.
Difficult market conditions and economic trends have recently and adversely affected the banking industry and could adversely affect our business, financial condition and results of operations in the future.
We are operating in an uncertain economic environment, including generally uncertain conditions nationally and locally in our industry and markets. Although economic conditions have improved in recent years, financial institutions continue to be affected by volatility in the real estate market in some parts of the country and uncertain regulatory and interest rate conditions. We retain direct exposure to the residential and commercial real estate markets in Texas and are affected by these events. In addition, financial institutions in Texas have been affected by the recent volatility in the oil and gas industry and significant decrease in energy prices. Our markets have also recently been affected by Hurricane Harvey, which may have an adverse impact on our business, financial condition and operations. See "Risk Factors—Risks Related to Our Business—Hurricanes or other adverse weather events in Texas can have an adverse impact on our business, financial condition and operations."
Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our loan portfolio is made more complex by uncertain market and economic conditions. Another national economic downturn or deterioration of conditions in our markets could result in losses beyond those that are provided for in our allowance for loan losses and lead to the following consequences:
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- increases in loan delinquencies;
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- increases in nonperforming assets and foreclosures;
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- decreases in demand for our products and services, which could adversely affect our liquidity position; and
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- decreases in the value of the collateral securing our loans, especially real estate, which could reduce customers' borrowing power and repayment ability.
While economic conditions in Texas and the United States continue to show signs of recovery, there can be no assurance that these conditions will continue to improve. Although real estate markets have generally stabilized in portions of the United States, including Texas, a resumption of declines in real estate values and home sales volumes, as well as financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse effect on our borrowers or their customers, which could adversely affect our business, financial condition and results of operations. In addition, continued volatility in the oil and gas industry and relatively low energy prices could have an adverse effect on our borrowers or their customers, including declines in real estate values and job losses, which could adversely affect our business, financial condition and results of operations.
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Sustained low oil prices, volatility in oil prices and downturns in the energy industry, including in Texas, could materially and adversely affect us.
The economy in Texas has dependence on the energy industry. A downturn or lack of growth in the energy industry and energy-related business, including sustained low oil prices or the failure of oil prices to rise in the future, could adversely affect our results of operations and financial condition. A prolonged period of low oil prices could also have a negative impact on the U.S. economy and, in particular, the economies of energy-dominant states such as Texas. Accordingly, a prolonged period of low oil prices could have a material adverse effect on our business, financial condition and results of operations. As of June 30, 2017, our direct and indirect energy lending comprised approximately 6.2% of our gross loans. Prolonged or heightened pricing pressure on oil and gas could lead to increased credit stress in our energy portfolio, increased losses associated with our energy portfolio, increased utilization of our contractual obligations to extend credit and weaker demand for energy lending. Such a decline or general uncertainty resulting from continued volatility could have other adverse impacts such as job losses in industries tied to energy, increased spending habits, lower borrowing needs, higher transaction deposit balances or a number of other effects that are difficult to isolate or quantify, particularly in states with significant dependence on the energy industry, such as Texas, all of which could have a material adverse effect on our business, financial condition and results of operations.
The small to medium-sized businesses that we lend to may have fewer resources to endure adverse business developments, which may impair our borrowers' ability to repay loans.
We focus our 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 to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower's ability to repay a loan. In addition, 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 death, disability or resignation of one or more of these people could have an adverse effect on the business and its ability to repay its loan. If our borrowers are unable to repay their loans, our business, financial condition and results of operations could be adversely affected.
A portion of our loan portfolio is comprised of commercial loans secured by receivables, inventory, equipment or other commercial collateral, which we refer to generally as commercial and industrial loans, and the deterioration in value of which could expose us to credit losses.
As of June 30, 2017, commercial and industrial loans represented approximately $535.1 million, or 24.4%, of our gross loans. In general, these loans are 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. These 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. Additionally, the repayment of commercial and industrial loans is subject to the ongoing business operations 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 we anticipate, thus exposing us to increased credit risk. In addition, a portion of our customer base, including customers in the energy and real estate business, may be in industries which are particularly sensitive to commodity prices or market fluctuations, such as energy and real estate prices. Accordingly, negative changes in commodity prices and real estate values and liquidity could impair the value of the collateral securing these loans. Significant adverse changes in the economy, local market conditions or adverse weather events in the markets in which our commercial and industrial lending customers operate could cause rapid declines in loan collectability and the values associated with general business assets resulting in inadequate collateral coverage that may expose us to credit losses and could
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adversely affect our business, financial condition and results of operations. See "Risk Factors—Risks Related to Our Business—Hurricanes or other adverse weather events in Texas can have an adverse impact on our business, financial condition and operations."
Our commercial real estate and real estate construction and development loan portfolio exposes us to credit risks that may be greater than the risks related to other types of loans.
As of June 30, 2017, approximately $898.3 million, or 40.9%, of our gross loans were nonresidential real estate loans (including owner-occupied commercial real estate loans) and approximately $434.0 million, or 19.8%, of our total loans were construction and development 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. Owner-occupied commercial real estate is generally less dependent upon income generated directly from the property but still carries risks from the successful operation of the underlying business or adverse economic conditions. These loans expose a lender to greater credit risk than loans secured by other types of collateral because the collateral securing these loans is typically more difficult to liquidate due to the fluctuation of real estate values. Additionally, non-owner-occupied commercial real estate loans generally involve relatively large balances to single borrowers or related groups of borrowers. Unexpected deterioration in the credit quality of our non-owner-occupied commercial real estate loan portfolio could require us to increase our allowance for loan losses, which would reduce our profitability and could have a material adverse effect on our business, financial condition and results of operations.
Construction and development loans also involve risks because loan funds are secured by a project under construction and the project is of uncertain value prior to its completion. 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 we are forced to foreclose on a project prior to completion, we may be unable to recover the entire unpaid portion of the loan. In addition, we 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 of time, any of which could adversely affect our business, financial condition and results of operations.
Because a significant portion of our loan portfolio is comprised of real estate loans, negative changes in the economy affecting real estate values and liquidity could impair the value of collateral securing our real estate loans and result in loan and other losses.
As of June 30, 2017, approximately $1.6 billion, or 71.6%, of our 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 over the last five years. The market value of real estate can fluctuate significantly in a short period of time. As a result, adverse developments affecting real estate values and the liquidity of real estate in our primary markets or in Texas generally could increase the credit risk associated with our loan portfolio, and could result in losses that adversely affect credit quality, financial condition and results of operations. Negative changes in the economy affecting real estate values and liquidity in our market areas could significantly impair the value of property pledged as collateral on loans and affect our ability to sell the collateral upon foreclosure without a loss or additional losses. Collateral may have to be sold for less than the outstanding balance of the loan, which could result in losses on such loans. Such declines and losses would have a material adverse effect on our business, financial condition and results of operations. If real estate values decline, it is also more likely that we would be required to increase our allowance for loan losses, which would
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adversely affect our business, financial condition and results of operations. In addition, adverse weather events, including hurricanes and flooding, can cause damages to the property pledged as collateral on loans, which could result in additional losses upon a foreclosure. See "Risk Factors—Risks Related to Our Business—Hurricanes or other adverse weather events in Texas can have an adverse impact on our business, financial condition and operations."
Appraisals and other valuation techniques we use in evaluating and monitoring loans secured by real property, other real estate owned and repossessed personal property may not accurately describe the net value of the asset.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values may change significantly in relatively short periods of time (especially in periods of heightened economic uncertainty), this estimate may not accurately describe the net value of the real property collateral after the loan is made. As a result, we may not be able to realize the full amount of any remaining indebtedness when we foreclose on and sell the relevant property. In addition, we rely on appraisals and other valuation techniques to establish the value of our OREO, and personal property that we acquire through foreclosure proceedings and to determine certain loan impairments. If any of these valuations are inaccurate, our combined and consolidated financial statements may not reflect the correct value of our OREO, and our allowance for loan losses may not reflect accurate loan impairments. This could have a material adverse effect on our business, financial condition or results of operations. As of June 30, 2017, we held approximately $1.4 million of OREO and did not hold any repossessed property and equipment.
We engage in lending secured by real estate and may be forced to foreclose on the collateral and own the underlying real estate, subjecting us to the costs and potential risks associated with the ownership of the real property, or consumer protection initiatives or changes in state or federal law may substantially raise the cost of foreclosure or prevent us from foreclosing at all.
Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we would be exposed to the risks inherent in the ownership of real estate. As of June 30, 2017, we held approximately $1.4 million of OREO. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to general or local economic condition, environmental cleanup liability, assessments, interest rates, 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. Our inability to manage the amount of costs or size of the risks associated with the ownership of real estate, or write-downs in the value of other real estate owned, could have a material adverse effect on our business, financial condition and results of operations.
Additionally, consumer protection initiatives or changes in state or federal law may substantially increase the time and expense associated with the foreclosure process or prevent us from foreclosing at all. While historically Texas has had foreclosure laws that are favorable to lenders, a number of states in recent years have either considered or adopted foreclosure reform laws that make it substantially more difficult and expensive for lenders to foreclose on properties in default, and we cannot be certain that Texas will not adopt similar legislation in the future. Additionally, federal regulators have prosecuted a number of mortgage servicing companies for alleged consumer law violations. If new state or federal laws or regulations are ultimately enacted that significantly raise the cost of foreclosure or raise outright barriers, such could have a material adverse effect on our business, financial condition and results of operations.
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Our largest loan relationships currently make up a material percentage of our total loan portfolio.
As of June 30, 2017 our 15 largest loan relationships (including related entities) totaled approximately $255.9 million in loans, or 10.3% of the total loan portfolio. 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, we could be at serious risk of material losses. The allowance for loan losses may not be adequate to cover losses associated with any of these relationships, and any loss or increase in the allowance would negatively affect our earnings and capital. Even if the loans are collateralized, the large increase in classified assets could harm our reputation with our regulators and inhibit our ability to execute our business plan.
Our largest deposit relationships currently make up a material percentage of our deposits and the withdrawal of deposits by our largest depositors could force us to fund our business through more expensive and less stable sources.
As of June 30, 2017, our 15 largest depositors (including related entities) accounted for $286.0 million in deposits, or approximately 11.4% of our total deposits. Further, our brokered deposit account balance was $99.2 million, or approximately 3.94% of our total deposits, as of June 30, 2017. Several of our large depositors have business, family, or other relationships with each other, which creates a risk that any one customer's withdrawal of its deposit could lead to a loss of other deposits from customers within the relationship.
Withdrawals of deposits by any one of our largest depositors or by one of our related customer groups could force us to rely more heavily on borrowings and other sources of funding for our business and withdrawal demands, adversely affecting our net interest margin and results of operations. We may also be forced, as a result of any withdrawal of deposits, to rely more heavily on other, potentially more expensive and less stable funding sources. Consequently, the occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.
A material portion of our loans and deposits are with related parties and our ability to continue do business with such related parties is highly regulated.
We have made loans to and accepted deposits from certain of our directors and officers and the directors and officers of the Bank in compliance with applicable regulations and our written policies. As of June 30, 2017, we had approximately $157.3 million of loans outstanding and approximately $69.4 million in unfunded loan commitments to such persons. In addition, we held related party deposits of approximately $239.5 million at June 30, 2017. Our business relationships with related parties are highly regulated. In particular, our ability to do business with related parties is limited with respect to, among other things, extensions of credit described in the Board of Governors of the Federal Reserve System's, or 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. These regulations could prevent us from pursuing activities that would otherwise be in our and our shareholders' best interests. Moreover, if we were to fail to comply with any of these regulations, we could be subject to enforcement and other legal actions by the Federal Reserve, which could have a material adverse effect on our business, financial condition and results of operations. See "Supervision and Regulation—CommunityBank of Texas, N.A.—Restrictions on Transactions with Affiliates and Insiders."
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We had significant deficiencies in internal control over financial reporting in the past and cannot assure you that additional significant deficiencies or material weaknesses will not be identified in the future. Our failure to implement and maintain effective internal control over financial reporting could result in material misstatements in our financial statements which could require us to restate financial statements, cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our common stock.
In the past, significant deficiencies have been identified in our 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 the company's financial reporting. Specifically, a significant deficiency was identified related to management's recorded amount of the Company's net deferred tax asset in 2014 that affected our financial statements for the fiscal years ended December 31, 2013 and prior periods, which resulted in a restatement of our financial statements for the year ended December 31, 2013. In 2015, significant deficiencies were identified including the Company's process related to our accounting for allowance for loan losses and related disclosures of impaired loans, business combination purchase accounting, and loan sales process. In addition, in 2015 and 2016, a significant deficiency was identified relating to financial statement disclosures and related review controls.
We have implemented measures designed to address the internal control significant deficiencies and expect to continue to implement measures designed to improve our internal control over financial reporting and disclosure controls and procedures. However, we cannot be certain that, at some point in the future, a significant deficiency or material weakness will not be identified or our internal controls will not fail to detect a matter they are designed to prevent, and failure to remedy such significant deficiencies or material weaknesses could result in a material misstatement in our financial statements and have a material adverse effect on our business, financial condition and results of operations. The identification of any additional significant deficiency or material weakness could also result in investors losing confidence in our internal controls and questioning our reported financial information, which, among other things, could have a negative effect on the trading price of our common stock. Additionally, we could become subject to increased regulatory scrutiny and a higher risk of shareholder litigation, which could result in significant additional expenses and require additional financial and management resources.
If we fail to maintain effective internal control over financial reporting, we may not be able to report our financial results accurately and timely, in which case our business may be harmed, investors may lose confidence in the accuracy and completeness of our financial reports, we could be subject to regulatory penalties and the price of our common stock may decline.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting and for evaluating and reporting on that system of internal control. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. As a public company, we will be required to comply with the Sarbanes-Oxley Act and other rules that govern public companies. In particular, we will be required to certify our compliance with Section 404 of the Sarbanes-Oxley Act beginning with our second annual report on Form 10-K, which will require us to furnish annually a report by management on the effectiveness of our internal control over financial reporting. In addition, unless we remain an emerging growth company and elect additional transitional relief available to emerging growth companies, our independent registered public accounting firm may be required to report on the effectiveness of our internal control over financial reporting beginning as of that second annual report on Form 10-K.
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We will continue to periodically test and update, as necessary, our internal control systems, including our financial reporting controls. In addition, we have hired additional accounting personnel in anticipation of our transition from a private company to a public company. Our actions, however, 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 our financial statements which in turn could harm our business, impair investor confidence in the accuracy and completeness of our financial reports, impair our access to the capital markets, cause the price of our common stock to decline and subject us to regulatory penalties.
We are dependent on the use of data and modeling in our management's decision-making, and faulty data or modeling approaches could negatively impact our decision-making ability or possibly subject us to regulatory scrutiny in the future.
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 our operations. Liquidity stress testing, interest rate sensitivity analysis, and the identification of possible violations of anti-money laundering regulations are all examples of areas in which we 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 we are not currently subject to annual Dodd-Frank Act stress testing, or DFAST, and the Comprehensive Capital Analysis and Review, or CCAR, submissions, we anticipate that model-derived testing may become more extensively implemented by regulators in the future.
We anticipate data-based modeling will penetrate further into bank decision-making, particularly risk management efforts, as the capacities developed to meet rigorous stress testing requirements are able to be employed more widely and in differing applications. While we believe these quantitative techniques and approaches improve our decision-making, they also create the possibility that faulty data or flawed quantitative approaches could negatively impact our decision-making ability or, if we become 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.
Delinquencies, defaults and foreclosures in residential mortgages create a higher risk of repurchases and indemnity requests.
We originate residential mortgage loans for sale to correspondent banks who may resell such mortgages to government-sponsored enterprises, such as Fannie Mae, Freddie Mac and other investors. As a part of this process, we make 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, we 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 we did not repurchase any residential mortgage loans sold to correspondent banks in 2015 or 2016, if we are forced to repurchase mortgage loans in the future that we have previously sold to investors, or indemnify those investors, our business, financial condition and results of operations could be adversely affected.
A lack of liquidity could impair our ability to fund operations and could have a material adverse effect on our business, financial condition and results of operations.
Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding. We require sufficient liquidity to meet customer loan requests, customer deposit maturities
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and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, the sale of our investment securities, the sale of loans, and other sources could have a substantial negative effect on our liquidity. Our most important source of funds is deposits. As of June 30, 2017, approximately $2.2 billion, or 85.9%, of our total deposits were noninterest-bearing deposits, negotiable order of withdrawal, or NOW, savings and money market accounts. Historically our savings, money market deposit accounts, NOW and demand accounts have been stable sources of funds. However, these deposits are subject to potentially dramatic fluctuations in availability or price due to certain factors that may be outside of our control, such as a loss of confidence by customers in us or the banking sector generally, customer perceptions of our financial health and general reputation, increasing competitive pressures from other financial services firms for consumer or corporate customer deposits, changes in interest rates and returns on other investment classes, which could result in 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 our funding costs and reducing our net interest income and net income.
The $355.5 million remaining balance of deposits consisted of certificates of deposit, of which $217.6 million, or 8.6% of our total deposits, were due to mature within one year. Historically, a majority of our certificates of deposit are renewed upon maturity as long as we pay competitive interest rates. These customers are, however, interest-rate conscious and may be willing to move funds into higher-yielding investment alternatives. If customers transfer money out of the Bank's deposits and into other investments such as money market funds, we would lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income.
Other primary sources of funds consist of cash flows from operations, maturities and sales of investment securities, and proceeds from the issuance and sale of our equity and debt securities to investors. Additional liquidity is provided by our ability to borrow from the Federal Reserve Bank of Dallas and the Federal Home Loan Bank of Dallas, or the FHLB. We also may borrow funds from third-party lenders, such as other financial institutions. Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us 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. Our access to funding sources could also be affected by a decrease in the level of our business activity as a result of a downturn in Texas or by one or more adverse regulatory actions against us.
Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have a material adverse effect on our business, financial condition and results of operations.
We may need to raise additional capital in the future, and such capital may not be available when needed or at all.
We may need to raise additional capital, in the form of additional debt or equity, in the future to have sufficient capital resources and liquidity to meet our commitments and fund our business needs and future growth, particularly if the quality of our assets or earnings were to deteriorate significantly. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial condition. Economic conditions and a loss of confidence in financial institutions may increase our cost of funding and limit
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access to certain customary sources of capital or make such capital only available on unfavorable terms, including interbank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve. We may not be able to obtain capital on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of our bank or counterparties participating in the capital markets or other disruption in capital markets, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. Further, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would then have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse effect on our business, financial condition and results of operations.
The borrowing needs of our clients may increase, especially in a challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit.
A commitment to extend credit is a formal agreement to lend funds to a client as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our clients under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Because of the credit profile of our clients, we typically have a substantial amount of total unfunded credit commitments, which is not reflected on our balance sheet. As of June 30, 2017, we had $552.4 million in unfunded credit commitments to our clients. Actual borrowing needs of our clients may exceed our expectations, especially during a challenging economic environment when our clients' companies may be more dependent on our credit commitments due to the lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from venture firms. This could adversely affect our liquidity, which could impair our ability to fund operations and meet obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations. See "Risk Factors—Risks Relating to Our Business—A lack of liquidity could impair our ability to fund operations and could have a material adverse effect on our business, financial condition and results of operations."
We face strong competition from financial services companies and other companies that offer banking services.
We operate in the highly competitive financial services industry and face significant competition for customers from financial institutions located both within and beyond our principal markets. We compete with commercial banks, savings banks, credit unions, nonbank financial services companies and other financial institutions operating within or near the areas we serve. Additionally, certain large banks headquartered outside of our markets and large community banking institutions target the same customers we do. In addition, as customer preferences and expectations continue to evolve, technology has lowered barriers to entry and made it possible for banks to expand their geographic reach by providing services over the internet and for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. The banking industry is experiencing rapid changes in technology, and, as a result, our future success will depend in part on our ability to address our customers' 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 following the recent downturn has also led to increased competitive pressures on loan rates and terms for high-quality credits. We may not be able to compete successfully with other financial institutions in our markets, and we 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 our nonbank competitors are not subject to the same extensive regulations that govern our activities and may have greater flexibility in competing for business. The financial services industry
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could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. In addition, some of our current commercial banking customers may seek alternative banking sources as they develop needs for credit facilities larger than we may be able to accommodate. Our inability to compete successfully in the markets in which we operate could have a material adverse effect on our business, financial condition or results of operations.
Negative public opinion regarding our company or failure to maintain our reputation in the communities we serve could adversely affect our business and prevent us from growing our business.
As a community bank, our reputation within the communities we serve is critical to our success. We believe we have set ourselves apart from our competitors by building strong personal and professional relationships with our customers and being active members of the communities we serve. As such, we strive to enhance our reputation by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve and delivering superior service to our customers. If our reputation is negatively affected by the actions of our employees or otherwise, we may be less successful in attracting new talent and customers or may lose existing customers, and our business, financial condition and results of operations could be adversely affected. Further, negative public opinion can expose us to litigation and regulatory action and delay and impede our efforts to implement our expansion strategy, which could further adversely affect our business, financial condition and results of operations.
We could recognize losses on investment securities held in our securities portfolio, particularly if interest rates increase or economic and market conditions deteriorate.
While we attempt to invest a significant majority of our total assets in loans (our loan-to-asset ratio was 74.6% as of June 30, 2017), we invest a percentage of our total assets (7.5% as of June 30, 2017) in investment securities with the primary objectives of providing a source of liquidity, providing an appropriate return on funds invested, managing interest rate risk, meeting pledging requirements and meeting regulatory capital requirements. As of June 30, 2017, the fair value of our available for sale investment securities portfolio was $220.3 million, which included a net unrealized loss of $17.0 million. Factors beyond our control can significantly and adversely influence the fair value of securities in our 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, 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 other-than-temporary impairment in future periods and result in realized losses. The process for determining whether impairment is other-than-temporary usually requires difficult, subjective judgments about the future financial performance of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security. Although we have not recognized other-than-temporary impairment related to our investment portfolio as of June 30, 2017, 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 us to recognize realized and/or unrealized losses in future periods, which could have a material adverse effect on our business, financial condition and results of operations.
The accuracy of our financial statements and related disclosures could be affected if the judgments, assumptions or estimates used in our critical accounting policies are inaccurate.
The preparation of financial statements and related disclosures in conformity with GAAP requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which are included in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of
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Operations" in this prospectus, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider "critical" because they require judgments, assumptions and estimates that materially affect our consolidated financial statements and related disclosures. As a result, if future events or regulatory views concerning such analysis differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events or assumptions could have a material impact on our consolidated financial statements and related disclosures, in each case resulting in our needing to revise or restate prior period financial statements, cause damage to our reputation and the price of our common stock, and adversely affect our business, financial condition and results of operations.
There could be material changes to our financial statements and disclosures if there are changes in accounting standards or regulatory interpretations of existing standards.
From time to time the FASB or the SEC may change the financial accounting and reporting standards that govern the preparation of our financial statements. Such changes may result in us being subject to new or changing 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 our control, can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, or apply an existing standard differently and retrospectively, in each case resulting in our needing to revise or restate prior period financial statements, which could materially change our financial statements and related disclosures, cause damage to our reputation and the price of our common stock, and adversely affect our business, financial condition and results of operations.
We depend on our information technology and telecommunications systems of third parties, and any systems failures, interruptions or data breaches involving these systems could adversely affect our operations and financial condition.
Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems including with third-party servicers and financial intermediaries. We outsource many of our major systems. Specifically, we rely on third parties for certain services, including, but not limited to, core systems processing, website hosting, internet services, monitoring our network and other processing services. Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, a cyber security breach involving any of our 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 interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. Replacing vendors or addressing other issues with our third-party service providers could entail significant delay, expense and disruption of service.
As a result, if these third-party service providers experience difficulties, are subject to cyber security breaches, or terminate their services, and we are unable to replace them with other service providers, particularly on a timely basis, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition and results of operations could be adversely affected. Even if we are able to replace third-party service providers, it may be at a higher cost to us, which could adversely affect our business, financial condition and results of operations.
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In addition, the Bank's primary federal regulator, the Office of the Comptroller of the Currency, or OCC, has recently issued guidance outlining the expectations for third-party service provider oversight and monitoring by financial institutions. The federal banking agencies, including the OCC, have recently issued enforcement actions against financial institutions for failure in oversight of third-party providers and violations of federal banking law by such providers when performing services for financial institutions. Accordingly, our operations could be interrupted if any of our third-party service providers experience difficulty, are subject to cyber security breaches, terminate their services or fail to comply with banking regulations, which could adversely affect our business, financial condition and results of operations. In addition, our failure to adequately oversee the actions of our third-party service providers could result in regulatory actions against the Bank, which could adversely affect our business, financial condition and results of operations.
System failure or cyber security breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses.
Our computer systems and network infrastructure could be vulnerable to hardware and cyber security issues. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. We could also experience a breach by intentional or negligent conduct on the part of employees or other internal sources. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect our computer systems and network infrastructure, including our digital, mobile and internet banking activities, against damage from physical break-ins, cyber security breaches and other disruptive problems caused by the internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability, damage our reputation and inhibit the use of our internet banking services by current and potential customers. We regularly add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cyber security breaches, including firewalls and penetration testing. However, it is difficult or impossible to defend against every risk being posed by changing technologies as well as acts of cyber-crime. Increasing sophistication of cyber criminals and terrorists make keeping up with new threats difficult and could result in a system breach. Controls employed by our information technology department and cloud vendors could prove inadequate. A breach of our security that results in unauthorized access to our data could expose us to a disruption or challenges relating to our daily operations, as well as to data loss, litigation, damages, fines and penalties, significant increases in compliance costs and reputational damage, any of which could have an adverse effect on our business, financial condition and results of operations.
We have a continuing need for technological change and we may not have the resources to effectively implement new technology, or we may experience operational challenges when implementing new technology, or technology needed to compete effectively with larger institutions may not be available to us on a cost effective basis.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, at least in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our products and service offerings. We may experience operational challenges as we implement these new technology enhancements or products, which could impair our ability to realize the
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anticipated benefits from such new technology or require us to incur significant costs to remedy any such challenges in a timely manner.
Many of our larger competitors have substantially greater resources to invest in technological improvements. Third parties upon which we rely for our technology needs may not be able to develop on a cost-effective basis systems that will enable us to keep pace with such developments. As a result, they may be able to offer additional or superior products compared to those that we will be able to provide, which would put us at a competitive disadvantage. We may lose customers seeking new technology-driven products and services to the extent we are unable to provide such products and services. Accordingly, the ability to keep pace with technological change is important and the failure to do so could adversely affect our business, financial condition and results of operations.
We are subject to laws regarding the privacy, information security and protection of personal information and any violation of these laws or another incident involving personal, confidential or proprietary information of individuals could damage our reputation and otherwise adversely affect our operations and financial condition.
Our business requires the collection and retention of large volumes of customer data, including personally identifiable information in various information systems that we maintain and in those maintained by third parties with whom we contract to provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. We are 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, our business is subject to the Gramm-Leach-Bliley Act which, among other things: (i) imposes certain limitations on our ability to share nonpublic personal information about our customers with nonaffiliated third parties; (ii) requires that we provide certain disclosures to customers about our information collection, sharing and security practices and afford customers the right to "opt out" of any information sharing by us with nonaffiliated third parties (with certain exceptions); and (iii) requires that we develop, implement and maintain a written comprehensive information security program containing appropriate safeguards based on our size and complexity, the nature and scope of our activities, and the sensitivity of customer information we process, as well as plans for responding to data security breaches. Various state and federal banking regulators and states have also enacted 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 our collection, use, transfer and storage of personal information complies with all applicable laws and regulations can increase our costs.
Furthermore, we may not be able to ensure that all of our clients, suppliers, counterparties and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, 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), we could be exposed to litigation or regulatory sanctions under personal information laws and regulations. Concerns regarding the effectiveness of our measures to safeguard personal information, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers for our products and services and thereby reduce our revenues. Accordingly, any failure or perceived failure to comply with applicable privacy or data protection laws and regulations may subject us 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 our reputation and otherwise adversely affect our operations and financial condition.
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We are subject to certain operational risks, including, but not limited to, customer, employee or third-party fraud and data processing system failures and errors.
Because we are a financial institution, employee errors and employee or customer misconduct could subject us in particular to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information, each of which can be particularly damaging for financial institutions. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.
We maintain 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 us from material losses associated with these risks, including losses resulting from any associated business interruption. If our 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 affect our business, financial condition and results of operations.
We depend on the accuracy and completeness of information provided to us by our borrowers and counterparties and any misrepresented information could adversely affect our business, results of operations and financial condition.
In deciding whether to approve loans or to enter into other transactions with borrowers and counterparties, we rely on information furnished to us by, or on behalf of, borrowers and counterparties, including financial statements, credit reports and other financial information. We also rely on representations of borrowers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the value of the loan may be significantly lower than expected and we may be subject to regulatory action. Whether a misrepresentation is made by the loan applicant, another third party, or one of our employees, we generally bear the risk of loss associated with the misrepresentation. Our controls and processes may not have detected, or may not detect all, misrepresented information in our loan originations or from our business clients. Any such misrepresented information could adversely affect our business, financial condition and results of operations.
We may be subject to environmental liabilities in connection with the real properties we own and the foreclosure on real estate assets securing our loan portfolio.
In the course of our business, we may purchase real estate in connection with our acquisition and expansion efforts, or we 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 we make. As a result, we could be subject to environmental liabilities with respect to those properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property.
The cost of removal or abatement may substantially exceed the value of the affected properties or the loans secured by those properties, we may not have adequate remedies against the prior owners or other responsible parties and we may not be able to resell the affected properties either before or after
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completion of any such removal or abatement procedures. If material environmental problems are discovered before foreclosure, we generally will not foreclose on the related collateral or will transfer ownership of the loan to a subsidiary. It should be noted, however, that the transfer of the property or loans to a subsidiary may not protect us from environmental liability. Furthermore, despite these actions on our part, the value of the property as collateral will generally be substantially reduced or we may elect not to foreclose on the property and, as a result, we may suffer a loss upon collection of the loan. Any significant environmental liabilities could have a material adverse effect on our business, financial condition and results of operations.
We are 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 our company, rely on technology companies to provide information technology products and services necessary to support their day-to-day operations. Technology companies frequently enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. Competitors of our vendors, or other individuals or companies, may from time to time claim to hold intellectual property sold to us by our vendors. 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, we may have to engage in protracted litigation. Such litigation is often expensive, time-consuming, disruptive to our operations and distracting to management. If we are found to infringe one or more patents or other intellectual property rights, we may be required to pay substantial damages or royalties to a third party. In certain cases, we may consider entering into licensing agreements for disputed intellectual property, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase our operating expenses. If legal matters related to intellectual property claims were resolved against us or settled, we could be required to make payments in amounts that could have a material adverse effect on our business, financial condition and results of operations.
In addition to litigation relating to intellectual property, we are regularly involved in litigation matters in the ordinary course of business. While we believe that these litigation matters should not have a material adverse effect on our business, financial condition, results of operations or future prospects, we may be unable to successfully defend or resolve any current or future litigation matters, in which case those litigation matters could have a material adverse effect on our business, financial condition and results of operations.
We have entered into employment agreements with certain of our officers, which may increase our compensation costs upon the occurrence of certain events or increase the cost of acquiring us.
We have entered into employment agreements with certain of our officers, which may increase our compensation costs upon the occurrence of certain events or increase the cost of acquiring us. In the event of termination of employment other than for cause, or in the event of certain types of termination following a change in control, as set forth in the relevant employment agreement, the agreement will provide for cash severance benefits based on such officer's current base salary and the terms of such agreement. For additional information see "Executive Compensation."
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If the goodwill that we have recorded or may record in connection with a business acquisition becomes impaired, it could require charges to earnings, which could have a material adverse effect on our business, financial condition and results of operations.
Goodwill represents the amount by which the cost of an acquisition exceeded the fair value of net assets we acquired in connection with the purchase of another financial institution. We review goodwill for impairment at least annually, or more frequently if a triggering event occurs which indicates that the carrying value of the asset might be impaired.
Our goodwill impairment test involves a two-step process. Under the first step, the estimation of fair value of the reporting unit is compared to its carrying value including goodwill. If step one indicates a potential impairment, the second step is performed to measure the amount of impairment, if any. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Any such adjustments are reflected in our results of operations in the periods in which they become known. As of June 30, 2017, our goodwill totaled $81.0 million. While we have not recorded any impairment charges since we initially recorded the goodwill, there can be no assurance that our future evaluations of our existing goodwill or goodwill we may acquire in the future will not result in findings of impairment and related write-downs, which could adversely affect our business, financial condition and results of operations.
Risks Related to the Regulation of Our Industry
We operate in a highly regulated environment and the laws and regulations that govern our operations, corporate governance, executive compensation and accounting principles, or changes in them, or our failure to comply with them, could adversely affect us.
Banking is highly regulated under federal and state law. As such, we are subject to extensive regulation, supervision and legal requirements that govern almost all aspects of our operations. These laws and regulations are not intended to protect our shareholders. Rather, these laws and regulations are intended to protect customers, depositors, the Deposit Insurance Fund and the overall financial stability of the United States. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on the business activities in which we can engage, limit the dividend or distributions that the Bank can pay to us, restrict the ability of institutions to guarantee our debt and impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than GAAP would require. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional operating costs. Our failure to comply with these laws and regulations, even if the failure follows good faith effort or reflects a difference in interpretation, could subject us to restrictions on our business activities, enforcement actions and fines and other penalties, any of which could adversely affect our results of operations, regulatory capital levels and the price of our securities. Further, any new laws, rules and regulations, such as the Dodd-Frank Act, could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition and results of operations.
The ongoing implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, could adversely affect our business, financial condition, and results of operations.
On July 21, 2010, the Dodd-Frank Act was signed into law, and the process of implementation is ongoing. The Dodd-Frank Act imposes significant regulatory and compliance changes on many industries, including ours. There remains significant uncertainty surrounding the manner in which the provisions of the Dodd-Frank Act will ultimately be implemented by the various regulatory agencies and the full extent of the impact of the requirements on our operations is unclear, especially in light of the Trump administration's recent executive order calling for a full review of the Dodd-Frank Act and
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the regulations promulgated under it. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, require the development of new compliance infrastructure, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements or with any future changes in laws or regulations could adversely affect our business, financial condition and results of operations.
Federal banking agencies periodically conduct examinations of our business, including compliance with laws and regulations, and our failure to comply with any supervisory actions to which we are or become subject as a result of such examinations could adversely affect us.
As part of the bank regulatory process, the OCC and the Federal Reserve System periodically conduct examinations of our business, including compliance with laws and regulations. If, as a result of an examination, 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 our operations have become unsatisfactory, or that our 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 our capital levels, to restrict our growth, to assess civil monetary penalties against us, 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. If we become subject to such regulatory actions, our business, financial condition, results of operations and reputation could be adversely affected.
We recently became subject to more stringent capital requirements, which may result in lower returns on equity, require the raising of additional capital, limit our ability to repurchase shares or pay dividends and discretionary bonuses, or result in regulatory action.
The Dodd-Frank Act requires the federal banking agencies to establish stricter risk-based capital requirements and leverage limits to apply to banks and bank and savings and loan holding companies. In July 2013, the federal banking agencies published new capital rules, referred to herein as the Basel III capital rules, which revised their risk-based and leverage capital requirements and their method for calculating risk-weighted assets. The Basel III capital rules apply to all bank holding companies with $1.0 billion or more in consolidated assets and all banks regardless of size. The Basel III capital rules became effective as applied to us on January 1, 2015, with a phase-in period for the new capital conservation buffer that generally extends from January 1, 2015 through January 1, 2019. See "Supervision and Regulation—CBTX, Inc.—Revised Rules on Regulatory Capital."
As a result of the enactment of the Basel III capital rules, we became subject to increased required capital levels. Our inability to comply with these more stringent capital requirements could, among other things, result in lower returns on equity; require the raising of additional capital; limit our ability to repurchase shares or pay dividends and discretionary bonuses; or result in regulatory actions, any of which could adversely affect our business, financial condition and results of operations.
Many of our new activities and expansion plans require regulatory approvals, and failure to obtain them may restrict our growth.
We intend to complement and expand our business by pursuing strategic acquisitions of financial institutions and other complementary businesses, and expansion of the Bank's banking location
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network, or de novo branching. Generally, we must receive federal regulatory approval before we can acquire a depository institution or related business insured by the Federal Deposit Insurance Corporation, or FDIC, or before we open a de novo branch. In determining whether to approve a proposed acquisition, federal banking regulators will consider, among other factors, the effect of the acquisition on competition, our financial condition, our future prospects, and the impact of the proposal on U.S. financial stability. The regulators also review current and projected capital ratios and levels, the competence, experience and integrity of management and its record of compliance with laws and regulations, the convenience and needs of the communities to be served (including the acquiring institution's record of compliance under the Community Reinvestment Act, or the CRA) and the effectiveness of the acquiring institution in combating money laundering activities. Such regulatory approvals may not be granted on terms that are acceptable to us, or at all. We may also be required to sell banking locations as a condition to receiving regulatory approval, which condition may not be acceptable to us or, if acceptable to us, may reduce the benefit of any acquisition.
Financial institutions, such as the Bank, face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network, established by the U.S. Department of the Treasury, or the Treasury Department, to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and the Internal Revenue Service. There is also increased scrutiny of compliance with the sanctions programs and rules administered and enforced by the Treasury Department's Office of Foreign Assets Control.
In order to comply with regulations, guidelines and examination procedures in this area, we have dedicated significant resources to our anti-money laundering program. If our policies, procedures and systems are deemed deficient, we could be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the inability to obtain regulatory approvals to proceed with certain aspects of our business plans, including acquisitions and de novo branching.
We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act, or CRA, and fair lending laws, 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 Consumer Financial Protection Bureau, or 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 effect on our business, financial
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condition and results of operations if any such rules limit our ability to provide such financial products or services.
A successful regulatory challenge to an institution'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 may also have the ability to challenge an institution's performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our 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 effect on our business, financial condition and results of operations.
The Office of Foreign Assets Control, or 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. We are 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. Through our Company and the Bank, and our agents and employees, we are subject to the Foreign Corrupt Practices Act, or the FCPA, 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 us.
Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.
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 our policy not to make predatory loans, but these laws create the potential for liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.
The expanding body of federal, state and local regulations and/or the licensing of loan servicing, collections or other aspects of our business and our sales of loans to third parties may increase the cost of compliance and the risks of noncompliance and subject us to litigation.
We service some of our own 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 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, we may incur additional significant costs to comply with such requirements, which may further adversely affect us. In addition, were we to be subject to regulatory investigation or
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regulatory action regarding our loan modification and foreclosure practices, our financial condition and results of operation could be adversely affected.
In addition, we and our legacy companies have sold loans to third parties. In connection with these sales, we or certain of our subsidiaries or legacy companies make or have made various representations and warranties, breaches of which may result in a requirement that we repurchase the loans, or otherwise make whole or provide other remedies to counterparties. These aspects of our business or our failure to comply with applicable laws and regulations could possibly lead to: civil and criminal liability; loss of licensure; damage to our reputation in the industry; fines and penalties and litigation, including class action lawsuits; and administrative enforcement actions. Any of these outcomes could materially and adversely affect us.
Potential limitations on incentive compensation contained in proposed federal agency rulemaking may adversely affect our ability to attract and retain our 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 manner in which we structure compensation for our executives and other employees. Depending on the nature and application of the final rules, we may not be able to successfully compete with certain financial institutions and other companies that are not subject to some or all of the rules to retain and attract executives and other high performing employees. If this were to occur, relationships that we have established with our clients may be impaired and our business, financial condition and results of operations could be adversely affected, perhaps materially.
Increases in FDIC insurance premiums could adversely affect our earnings and results of operations.
We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. As a result of economic conditions and the enactment of the Dodd-Frank Act, the FDIC has in recent years increased deposit insurance assessment rates, which in turn raised deposit premiums for many insured depository institutions. 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 insurance fund's reserve ratio, and the FDIC has put in place a restoration plan to restore the Deposit Insurance Fund to its 1.35% minimum reserve ratio managed by the Dodd-Frank Act by September 30, 2020. If recent increases in premiums are insufficient for the Deposit Insurance Fund to meet its funding requirements, further 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, we may be required to pay higher FDIC premiums. Our FDIC insurance related costs were approximately $1.7 million for the years ended December 31, 2016 and December 31, 2015. Any future additional assessments, increases or required prepayments in FDIC insurance premiums could adversely affect our earnings and results of operations.
The Federal Reserve may require us 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
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subsidiary bank. Accordingly, we 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 our resources are limited, and we 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 holding company for the purpose of making a capital injection to a subsidiary bank often becomes more difficult and expensive relative to other corporate borrowings.
We could be adversely affected by the soundness of other financial institutions.
Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and routinely execute 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 us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when our collateral cannot be foreclosed upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due. Any such losses could adversely affect our business, financial condition and results of operations.
Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.
In addition to being affected by general economic conditions, our 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 by the Federal Reserve, 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 effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Although we cannot determine the effects of such policies on us at this time, such policies could adversely affect our business, financial condition and results of operations.
We are subject to commercial real estate lending guidance issued by the federal banking regulators that impacts our 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. Under the guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors, (1) total reported loans for construction, land acquisition and development, and other land represent 100% or more of total capital, or (2) total reported loans secured by multi-family and nonfarm residential properties, loans for construction, land acquisition and development and other land, and loans
44
otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. At June 30, 2017, the Bank's ratios under these tests were 125.1% and 300.0%, respectively. The particular 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 states 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 we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us or that may result in a curtailment of our commercial real estate lending and/or the requirement that we maintain higher levels of regulatory capital, either of which would adversely affect our loan originations and profitability.
Risks Related to an Investment in our Common Stock
There is currently no regular market for our common stock. An active, liquid market for our common stock may not develop or be sustained upon completion of this offering, which may impair your ability to sell your shares.
Our common stock is not currently traded on an established public trading market. As a result, there is no regular market for our common stock. We have applied to list our common stock on the Nasdaq Global Select Market, but an active, liquid trading market for our common stock may not develop or be sustained following this offering. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace and independent decisions of willing buyers and sellers of our common stock, over which we have no control. Without an active, liquid trading market for our common stock, shareholders may not be able to sell their shares at the volume, prices and times desired. Moreover, the lack of an established market could materially and adversely affect the value of our common stock. The market price of our common stock could decline significantly due to actual or anticipated issuances or sales of our common stock in the future.
The market price of our common stock may be subject to substantial fluctuations, which may make it difficult for you to sell your shares at the volume, prices and times desired.
The market price of our common stock may be highly volatile, which may make it difficult for you to resell your shares at the volume, prices and times desired. There are many factors that may affect the market price and trading volume of our common stock, including, without limitation:
- •
- actual or anticipated fluctuations in our operating results, financial condition or asset quality;
- •
- changes in economic or business conditions;
- •
- the effects of, and changes in, trade, monetary and fiscal policies, including the interest rate policies of the Federal Reserve;
- •
- publication of research reports about us, our competitors, or the financial services industry generally, or changes in, or failure to meet,
securities analysts' estimates of our financial and operating performance, or lack of research reports by industry analysts or ceasing of coverage;
- •
- operating and stock price performance of companies that investors deemed comparable to us;
45
- •
- additional or anticipated sales of our common stock or other securities by us or our existing shareholders;
- •
- additions or departures of key personnel;
- •
- perceptions in the marketplace regarding our competitors or us, including the perception that investment in Texas is unattractive or less
attractive during periods of low oil prices;
- •
- significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving our
competitors or us;
- •
- other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services; and
- •
- other news, announcements or disclosures (whether by us or others) related to us, our competitors, our primary markets or the financial services industry.
The stock market and, in particular, 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 particular companies. In addition, significant fluctuations in the trading volume in our common stock may cause significant price variations to occur. Increased market volatility may materially and adversely affect the market price of our common stock, which could make it difficult to sell your shares at the volume, prices and times desired.
The market price of our common stock could decline significantly due to actual or anticipated issuances or sales of our common stock in the future.
Actual or anticipated issuances or sales of substantial amounts of our common stock following this offering could cause the market price of our common stock to decline significantly and make it more difficult for us to sell equity or equity-related securities in the future at a time and on terms that we deem appropriate. The issuance of any shares of our common stock in the future also would, and equity-related securities could, dilute the percentage ownership interest held by shareholders prior to such issuance. Our certificate of formation authorizes us to issue up to 90,000,000 shares of our common stock, 24,463,072 of which will be outstanding following the completion of this offering (or 24,823,072 shares if the underwriters exercise in full their option to purchase additional shares). All of the shares of common stock sold in this offering will be freely tradable, except that any shares purchased by our "affiliates" (as that term is defined in Rule 144 under the Securities Act of 1933, as amended, or the Securities Act) may be resold only in compliance with the limitations described under "Shares Eligible for Future Sale." The remaining 22,063,072 outstanding shares of our common stock will be deemed to be "restricted securities" as that term is defined in Rule 144, and may be resold in the United States only if they are registered for resale under the Securities Act or an exemption, such as Rule 144, is available. We also intend to file a registration statement on Form S-8 under the Securities Act to register an aggregate of approximately 895,314 shares of common stock issued or reserved for issuance under our equity incentive plans. We may issue all of these shares without any action or approval by our shareholders, and these shares, once issued (including upon exercise of outstanding options), will be available for sale into the public market, subject to the restrictions described above, if applicable, for affiliate holders.
Further, in connection with this offering, we, our directors, our executive officers and certain shareholders have agreed to enter into lock-up agreements that restrict the sale of their holdings of our common stock for a period of 180 days from the date of this prospectus. The underwriters, in their discretion, may release any of the shares of our common stock subject to these lock-up agreement at any time without notice. In addition, after this offering, approximately 16,307,852 shares of our common stock will not be subject to lock-up. The resale of such shares could cause the market price of
46
our stock to drop significantly, and concerns that those sales may occur could cause the trading price of our common stock to decrease or to be lower than it should be.
In addition, we may issue shares of our common stock or other securities from time to time as consideration for future acquisitions and investments and pursuant to compensation and incentive plans. If any such acquisition or investment is significant, the number of shares of our common stock, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be substantial. We may also grant registration rights covering those shares of our common stock or other securities in connection with any such acquisitions and investments.
We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of our common stock will have on the market price of our common stock. Sales of substantial amounts of our common stock (including shares of our common stock issued in connection with an acquisition or under a compensation or incentive plan), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through future sales of our securities.
The obligations associated with being a public company will require significant resources and management attention, which will increase our costs of operations and may divert focus from our business operations.
As a public company, we will face increased legal, accounting, administrative and other costs and expenses that we have not incurred as a private company, particularly after we no longer qualify as an emerging growth company. We expect to incur incremental costs related to operating as a public company of approximately $700,000 annually, although there can be no assurance that these costs will not be higher, particularly when we no longer qualify as an emerging growth company. After the completion of this offering, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which requires that we file annual, quarterly and current reports with respect to our business and financial condition and proxy and other information statements, and the rules and regulations implemented by the SEC, the Sarbanes-Oxley Act, the Dodd-Frank Act, the PCAOB and the Nasdaq Global Select Market, 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 the Nasdaq Global Select Market rules will make certain operating activities more time-consuming, and we will also incur significant new legal, accounting, insurance and other expenses. Furthermore, the need to establish the corporate infrastructure demanded of a public company may divert management's attention from implementing our operating strategy, which could prevent us from successfully implementing our strategic initiatives and improving our results of operations. We have made, and will continue to make, changes to our internal controls and procedures for financial reporting and accounting systems to meet our reporting obligations as a public company. However, we cannot predict or estimate the amount of additional costs we may incur in order to comply with these requirements. We anticipate that these costs will materially increase our general and administrative expenses and such increases will reduce our profitability.
Investors in this offering will experience immediate and substantial dilution.
The initial public offering price is expected to be substantially higher than the tangible book value per share of our common stock immediately following this offering. Therefore, if you purchase shares in this offering, you will experience immediate and substantial dilution in tangible book value per share in relation to the price that you paid for your shares. We expect the dilution as a result of this offering to be $11.21 per share, based on an assumed initial public offering price of $25.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and our pro forma tangible book value of $13.79 per share as of June 30, 2017. Accordingly, if we were liquidated at our pro forma tangible book value, you would not receive the full amount of your investment. See "Dilution."
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Securities analysts may not initiate or continue coverage on us.
The trading market for our common stock will depend, in part, on the research and reports that securities analysts publish about us and our business. We do not have any control over these securities analysts, and they may not cover us. If one or more of these analysts cease to cover us or fail to publish regular reports on us, we could lose visibility in the financial markets, which could cause the price or trading volume of our common stock to decline. If we are covered by securities analysts and are the subject of an unfavorable report, the price of our common stock may decline.
Our management and board of directors have significant control over our business.
As of October 19, 2017, our directors and executive officers beneficially owned an aggregate of 7,126,792 shares, or approximately 32.2% of our issued and outstanding shares of common stock.
Following the completion of this offering, our directors and executive officers will beneficially own approximately 29.4% of our outstanding common stock as a group (or 29.0% if the underwriters exercise in full their option to purchase additional shares), including shares of restricted stock granted in connection with this offering, but excluding any shares that may be purchased in this offering by our directors and executive officers through the directed share program described in "Underwriting—Directed Share Program." Consequently, our management and board of directors may be able to significantly affect our affairs and policies, including the outcome of the election of directors and the potential outcome of other matters submitted to a vote of our shareholders, such as mergers, the sale of substantially all of our 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 our other shareholders to approve transactions that they may deem to be in the best interests of our Company. The interests of these insiders could conflict with the interests of our other shareholders, including you.
We have broad discretion in the use of the net proceeds to us from this offering, and our use of these proceeds may not yield a favorable return on your investment.
We intend to use the net proceeds to us from this offering to further implement our expansion strategy, fund organic growth in our banking markets and for general corporate purposes. We have not specifically allocated the amount of net proceeds to us that will be used for these purposes and our management will have broad discretion over how these proceeds are used and could spend these proceeds in ways with which you may not agree. In addition, we may not use the net proceeds to us from this offering effectively or in a manner that increases our market value or enhances our profitability. We have not established a timetable for the effective deployment of the net proceeds to us, and we cannot predict how long it will take to deploy these proceeds. Investing the net proceeds to us in securities until we are able to deploy these proceeds will provide lower yields than we generally earn on loans, which may have an adverse effect on our profitability. Although we may, from time to time in the ordinary course of business, evaluate potential acquisition opportunities that we believe provide attractive risk-adjusted returns, we do not have any immediate plans, arrangements or understandings relating to any acquisitions, nor are we engaged in negotiations with any potential acquisition targets. Likewise, although we regularly consider establishing de novo banking locations and organic growth initiatives within our current and potential new markets, we do not have any immediate plans, arrangements or understandings relating to the establishment of any de novo banking locations or any other organic growth initiatives outside of the ordinary course of business.
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The holders of our existing debt obligations, as well as debt obligations that may be outstanding in the future, will have priority over our 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, our common stock would rank below all claims of debt holders against us. As of June 30, 2017, we had outstanding approximately $25.5 million of senior debt obligations relating to advances on our line of credit loan secured by the capital stock of the Bank, and approximately $6.7 million in aggregate principal amount of junior subordinated debentures issued to statutory trusts that, in turn, have issued and outstanding $10.5 million of trust preferred securities. Payments of the principal and interest on the trust preferred securities are conditionally guaranteed by us. Our debt obligations are senior to our shares of common stock. As a result, we must make payments on our debt obligations before any dividends can be paid on our common stock. In the event of our bankruptcy, dissolution or liquidation, the holders of our debt obligations must be satisfied before any distributions can be made to the holders of our common stock. We have the right to defer distributions on our junior subordinated debentures (and the related trust preferred securities) for up to five years, during which time no dividends may be paid to holders of our common stock. To the extent that we issue additional debt obligations or junior subordinated debentures, the additional debt obligations or additional junior subordinated debentures will be of equal rank with, or senior to, our existing debt obligations and senior to our shares of common stock.
We may issue shares of preferred stock in the future, which could make it difficult for another company to acquire us or could otherwise adversely affect holders of our common stock, which could depress the price of our common stock.
Our certificate of formation authorizes us to issue up to 10,000,000 shares of one or more series of preferred stock. Our 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 our shareholders. Our preferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of our common stock. The potential issuance of preferred stock may delay or prevent a change in control of us, discourage bids for our common stock at a premium over the market price and materially adversely affect the market price and the voting and other rights of the holders of our common stock.
We are dependent upon the Bank for cash flow, and the Bank's ability to make cash distributions is restricted.
Our primary tangible asset is the stock of the Bank. As such, we depend upon the Bank for cash distributions (through dividends on the Bank's common stock) that we use to pay our operating expenses, satisfy our obligations (including our subordinated debentures and our other debt obligations) and to pay dividends on our common stock. Federal statutes, regulations and policies restrict the Bank's ability to make cash distributions to us. 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 has the ability to restrict the Bank's payment of dividends by supervisory action. If the Bank is unable to pay dividends to us, we will not be able to satisfy our obligations or pay dividends on our common stock.
Our dividend policy may change without notice, and our future ability to pay dividends is subject to restrictions.
Historically, our board of directors has declared dividends on our common stock payable in the month following the end of each calendar quarter, and we anticipate that following this offering, we will continue paying a quarterly dividend on our common stock in an amount equal to approximately $0.05 per share per quarter. Although we have historically paid dividends to our shareholders and currently intend to generally maintain our current dividend levels, we have no obligation to continue
49
doing so and may change our dividend policy at any time without notice to holders of our common stock. Holders of our common stock are only entitled to receive such cash dividends as our board of directors, in its discretion, may declare out of funds legally available for such payments. Furthermore, consistent with our strategic plans, growth initiatives, capital availability, projected liquidity needs, and other factors, we have made, and will continue to make, capital management decisions and policies that could adversely impact the amount of dividends paid to holders of our common stock.
We are a separate and distinct legal entity from the Bank. We receive substantially all of our revenue from dividends paid to us by the Bank, which we use as the principal source of funds to pay our expenses and to pay dividends to our shareholders, if any. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay us. If the Bank does not receive regulatory approval or does not maintain a level of capital sufficient to permit it to make dividend payments to us while maintaining adequate capital levels, our ability to pay our expenses and our business, financial condition or results of operations could be materially and adversely impacted.
As a bank holding company, we are subject to regulation by the Federal Reserve. The Federal Reserve has indicated that bank holding companies should carefully review their dividend policy in relation to the organization's overall asset quality, current and prospective earnings and level, composition and quality of capital. The guidance provides that we 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 our capital structure, including interest on the subordinated debentures underlying our trust preferred securities and our other debt obligations. If required payments on our outstanding junior subordinated debentures, held by our unconsolidated subsidiary trusts, or our other debt obligations, are not made or are deferred, or dividends on any preferred stock we may issue are not paid, we will be prohibited from paying dividends on our common stock.
Our corporate organizational documents and provisions of federal and state law to which we are subject contain certain provisions that could have an anti-takeover effect and may delay, make more difficult or prevent an attempted acquisition that you may favor or an attempted replacement of our board of directors or management.
Our certificate of formation and our bylaws (each as amended and restated and in effect prior to the completion of this offering) may have an anti-takeover effect and may delay, discourage or prevent an attempted acquisition or change of control or a replacement of our incumbent board of directors or management. Our governing documents include provisions that:
- •
- empower our board of directors, without shareholder approval, to issue our preferred stock, the terms of which, including voting power, are to
be set by our board of directors;
- •
- establish a classified board of directors, with directors of each class serving a three-year term upon completion of a phase-in period;
- •
- provide that directors may only be removed from office for cause and only upon a majority shareholder vote;
- •
- eliminate cumulative voting in elections of directors;
- •
- permit our board of directors to alter, amend or repeal our amended and restated bylaws or to adopt new bylaws;
- •
- require the request of holders of at least 50.0% of the outstanding shares of our capital stock entitled to vote at a meeting to call a special
shareholders' meeting;
- •
- prohibit shareholder action by less than unanimous written consent, thereby requiring virtually all actions to be taken at a meeting of the shareholders;
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- •
- require shareholders that wish to bring business before annual or special meetings of shareholders, or to nominate candidates for election as
directors at our annual meeting of shareholders, to provide timely notice of their intent in writing; and
- •
- enable our board of directors to increase, between annual meetings, the number of persons serving as directors and to fill the vacancies created as a result of the increase by a majority vote of the directors present at a meeting of directors.
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 Bank Holding Company Act of 1956, as amended, or the BHC Act, and the Change in Bank Control Act, or the CBCA. These laws could delay or prevent an acquisition.
Furthermore, our amended and restated certificate of formation provides that the state courts located in Jefferson County, Texas, the county in which Beaumont is located, will be the exclusive forum for: (a) any actual or purported derivative action or proceeding brought on our behalf; (b) any action asserting a claim of breach of fiduciary duty by any of our directors or officers; (c) any action asserting a claim against us or our directors or officers arising pursuant to the Texas Business Organizations Code, or TBOC, our certificate of formation, or our amended and restated bylaws; or (d) any action asserting a claim against us or our officers or directors that is governed by the internal affairs doctrine. By becoming a shareholder of our Company, you will be deemed to have notice of and have consented to the provisions of our amended and restated certificate of formation related to choice of forum. The choice of forum provision in our amended and restated certificate of formation may limit our shareholders' ability to obtain a favorable judicial forum for disputes with us. Alternatively, if a court were to find the choice of forum provision contained in our amended and restated certificate of formation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business, operating results and financial condition.
The return on your investment in our common stock is uncertain.
An investor in our common stock may not realize a substantial return on his or her investment, or may not realize any return at all. Further, as a result of the uncertainty and risks associated with our operations, many of which are described in this "Risk Factors" section, it is possible that an investor could lose his or her entire investment.
An investment in our common stock is not an insured deposit and is subject to risk of loss.
Any shares of our common stock you purchase in this offering will not be savings accounts, deposits or other obligations of any of our bank or nonbank subsidiaries and will not be insured or guaranteed by the FDIC or any other government agency. Your investment will be subject to investment risk, and you must be capable of affording the loss of your entire investment.
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. These forward-looking statements reflect our current views with respect to, among other things, future events and our 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 our industry, management's beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you 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 we believe 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 our actual results to differ materially from those indicated in these forward-looking statements, including, but not limited to, the following:
- •
- our expected financial results as of and for the three and nine months ended September 30, 2017;
- •
- the effect of Hurricane Harvey on our markets and business;
- •
- natural disasters and adverse weather, acts of terrorism, an outbreak of hostilities or other international or domestic calamities, and other
matters beyond our control;
- •
- the geographic concentration of our markets in Beaumont and Houston, Texas;
- •
- our ability to prudently manage our growth and execute our strategy;
- •
- risks associated with our acquisition and de novo branching strategy;
- •
- changes in management personnel;
- •
- the amount of nonperforming and classified assets that we hold;
- •
- time and effort necessary to resolve nonperforming assets;
- •
- deterioration of our asset quality;
- •
- interest rate risk associated with our business;
- •
- business and economic conditions generally and in the financial services industry, nationally and within our primary markets;
- •
- volatility and direction of oil prices and the strength of the energy industry, generally and within Texas;
- •
- the composition of our loan portfolio, including the identity of our borrowers and the concentration of loans in specialized industries;
- •
- changes in the value of collateral securing our loans;
- •
- our ability to maintain important deposit customer relationships and our reputation;
- •
- our ability to maintain effective internal control over financial reporting;
- •
- operational risks associated with our business;
52
- •
- increased competition in the financial services industry, particularly from regional and national institutions;
- •
- volatility and direction of market interest rates;
- •
- liquidity risks associated with our business;
- •
- systems failures or interruptions involving our information technology and telecommunications systems or third-party servicers;
- •
- environmental liability associated with our lending activities;
- •
- the institution and outcome of litigation and other legal proceedings against us or to which we may become subject;
- •
- changes in the laws, rules, regulations, interpretations or policies relating to financial institution, accounting, tax, trade, monetary and
fiscal matters;
- •
- further government intervention in the U.S. financial system; and
- •
- other factors that are discussed in the section entitled "Risk Factors," beginning on page 18.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this prospectus. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
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Assuming an initial public offering price of $25.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus, we estimate that the net proceeds to us from the sale of our common stock in this offering, after deducting underwriting discounts and estimated offering expenses payable by us, will be approximately $53.5 million, or approximately $61.9 million if the underwriters exercise in full their option to purchase additional shares.
Each $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the net proceeds to us of this offering by $2.2 million, or $2.6 million if the underwriters exercise in full their option to purchase additional shares, after deducting underwriting discounts and estimated offering expenses payable by us.
We intend to use the net proceeds from this offering to support our organic growth and for general corporate purposes, including maintenance of our required regulatory capital, and potential future acquisition opportunities. From time to time, we evaluate and conduct due diligence with respect to potential acquisition candidates and may enter into letters of intent, although we do not have any current plans, arrangements or understandings to make material acquisitions. Our management will retain broad discretion to allocate the net proceeds of this offering and we may elect to contribute a portion of the net proceeds to the Bank as regulatory capital. The precise amounts and timing of our use of the proceeds will depend upon market conditions and other factors.
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Dividends
It has been our policy to pay a dividend to our shareholders as a return on their investment. We have historically declared dividends in the amount of $0.05 per share payable in the month following the end of each calendar quarter.
We intend to continue our current dividend policy of quarterly dividends of $0.05 per share; however, our dividend policy may change with respect to the payment of dividends as a return on investment, and our board of directors may change or eliminate the payment of future dividends at its discretion, without notice to our shareholders. Any future determination to pay dividends to holders of our common stock will be dependent upon our results of operations, financial condition, capital requirements, banking regulations, contractual restrictions (including the restrictions discussed below), and any other factors that our board of directors may deem relevant.
The following table shows recent quarterly dividends that have been paid on our common stock with respect to the periods indicated. The amounts set forth in the following table have been adjusted to give effect to a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each share owned as of the record date of September 30, 2017, in the form of a stock dividend that was distributed on October 13, 2017. The effect of the stock split on per share figures has been retroactively applied to all periods presented.
(Dollars in thousands, except per share data)
|
Per share dividend amount |
Total cash dividends declared |
|||||
|---|---|---|---|---|---|---|---|
2015: |
|||||||
First quarter |
$ | 0.05 | $ | 1,125 | |||
Second quarter |
0.05 | 1,125 | |||||
Third quarter |
0.05 | 1,122 | |||||
Fourth quarter |
0.05 | 1,115 | |||||
| | | | | | | | |
Total 2015 |
$ | 0.20 | $ | 4,487 | |||
2016: |
|||||||
First quarter |
$ | 0.05 | $ | 1,120 | |||
Second quarter |
0.05 | 1,090 | |||||
Third quarter |
0.05 | 1,083 | |||||
Fourth quarter |
0.05 | 1,103 | |||||
| | | | | | | | |
Total 2016 |
$ | 0.20 | $ | 4,396 | |||
2017: |
|||||||
First quarter |
$ | 0.05 | $ | 1,103 | |||
Second quarter |
0.05 | 1,103 | |||||
Third quarter |
$ | 0.05 | $ | 1,103 | |||
Dividend Restrictions
As a bank holding company, our ability to pay dividends is affected by the policies and enforcement powers of the Federal Reserve. See "Supervision and Regulation—CBTX, Inc.—Regulatory Restrictions on Dividends; Source of Strength." In addition, because we are a holding company, we are dependent upon the payment of dividends by the Bank to us as our principal source of funds to pay dividends in the future, if any, and to make other payments. The Bank is also subject to various legal, regulatory and other restrictions on its ability to pay dividends and make other distributions and payments to us. See "Supervision and Regulation—CommunityBank of Texas, N.A.—Restrictions on Distribution of Bank Dividends and Assets." The present and future dividend policy of
55
the Bank is subject to the discretion of the board of directors of the Bank. The Bank is not obligated to pay us dividends.
As a Texas corporation, we are subject to certain restrictions on distributions under TBOC. Generally, a Texas corporation may not make a distribution to its shareholders if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business, or the corporation's total assets would be less than the sum of its total liabilities plus the amount that would be needed if the corporation were to be dissolved at the time of the distribution to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. In addition, if required payments on our outstanding debt obligations, including our junior subordinated debentures held by our unconsolidated subsidiary trusts, are not made or suspended, we may be prohibited from paying dividends on our common stock. We are also subject to certain restrictions on our right to pay dividends to our shareholders in the event we default under the terms of our note payable.
56
The following table sets forth our capitalization, including regulatory capital ratios, on a consolidated basis, as of June 30, 2017 on:
- •
- an actual basis; and
- •
- an as adjusted basis after giving effect to the net proceeds from the sale by us of shares of common stock in this offering (assuming the underwriters do not exercise their option to purchase additional shares) at the initial public offering price of $25.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus, after deducting underwriting discounts and estimated offering expenses payable by us.
This table should be read in conjunction with "Use of Proceeds," "Selected Historical Consolidated Financial Data," "Description of Capital Stock," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes included elsewhere in this prospectus. The outstanding share and per share data set forth in the following table have been adjusted to give effect to a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each share owned as of the record date of September 30, 2017 in the form of a stock dividend that was distributed on October 13, 2017.
| |
As of June 30, 2017 | ||||||
|---|---|---|---|---|---|---|---|
(Dollars in thousands, except per share data)
|
Actual | As adjusted for the offering(1) |
|||||
Long-term Indebtedness: |
|||||||
Junior subordinated debt(2) |
$ | 6,726 | $ | 6,726 | |||
Notes payable |
25,464 | 25,464 | |||||
Shareholders' Equity: |
|||||||
Preferred Stock, par value $0.01 per share, 10,000,000 shares authorized, no shares issued |
$ | — | $ | — | |||
Common stock, par value $0.01 per share, 90,000,000 shares authorized, 22,971,504 shares issued and 22,063,072 outstanding (actual); and 25,371,504 shares issued and 24,463,072 outstanding (as adjusted) |
230 | 254 | |||||
Additional Paid in Capital |
278,517 | 332,015 | |||||
Retained earnings |
108,635 | 108,635 | |||||
Treasury stock (908,432 shares) |
(15,429 | ) | (15,429 | ) | |||
Accumulated other comprehensive income |
11 | 11 | |||||
| | | | | | | | |
Total shareholders' equity |
371,964 | 425,485 | |||||
| | | | | | | | |
Total capitalization |
$ | 404,154 | $ | 457,675 | |||
Per Share Data: |
|||||||
Book value per share(3) |
$ | 16.86 | $ | 17.39 | |||
Tangible book value per share(4) |
$ | 12.86 | $ | 13.79 | |||
Capital Ratios: |
|||||||
Total shareholders' equity to total assets |
12.65 | % | 14.21 | % | |||
Tangible equity to tangible assets(5) |
9.95 | % | 11.60 | % | |||
Common equity tier 1 capital ratio |
12.00 | % | 14.16 | % | |||
Tier 1 leverage ratio |
10.39 | % | 12.06 | % | |||
Tier 1 risk-based capital ratio |
12.26 | % | 14.43 | % | |||
Total risk-based capital ratio |
13.33 | % | 15.49 | % | |||
- (1)
- References in this section to the number of shares of our common stock issued and outstanding after this offering are based on shares of our common stock issued and outstanding as of June 30,
57
2017 after giving effect to the 2-for-1 stock split previously described. Unless otherwise noted, these references exclude any shares reserved for issuance under our equity compensation plans.
- (2)
- Consists
of debt issued in connection with our trust preferred securities.
- (3)
- We
calculate book value per share as total shareholders' equity at the end of the relevant period divided by the outstanding number of shares of our common stock at
the end of the relevant period.
- (4)
- Tangible
book value per share is a non-GAAP financial measure. The most directly comparable GAAP financial measure is book value per share. We calculate tangible
book value per share as total shareholders' equity, less goodwill and other intangible assets, net of accumulated amortization at the end of the relevant period, divided by the outstanding number of
shares of our common stock at the end of the relevant period. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption
"Non-GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures."
- (5)
- Tangible equity to tangible assets is a non-GAAP financial measure. The most directly comparable GAAP financial measure is total shareholders' equity to total assets. We calculate tangible equity as total shareholders' equity, less goodwill and other intangible assets, net of accumulated amortization, and we calculate tangible assets as total assets, less goodwill and other intangible assets, net of accumulated amortization. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption "Non-GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures."
Each $1.00 increase (decrease) in the assumed initial public offering price of $25.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease), respectively, the amount of total shareholders' equity and total capitalization by approximately $2.2 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and estimated offering expenses payable by us.
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If you invest in our common stock, your ownership interest will be diluted to the extent that the initial public offering price per share of our common stock exceeds the tangible book value per share of our common stock immediately following this offering. Tangible book value per share is equal to our total shareholders' equity, less goodwill and other intangible assets, net of accumulated amortization at the end of the relevant period, divided by the outstanding number of shares of our common stock at the end of the relevant period. At June 30, 2017, the tangible book value of our common stock was $283.7 million, or $12.86 per share.
After giving effect to our sale of 2,400,000 shares of common stock in this offering (assuming the underwriters do not exercise their option to purchase additional shares) at an assumed initial public offering price of $25.00 per share, which is the midpoint of the price range on the cover page of this prospectus, and after deducting underwriting discounts and estimated offering expenses payable by us, the pro forma tangible book value of our common stock at June 30, 2017 would have been approximately $337.2 million, or $13.79 per share. Therefore, this offering will result in an immediate increase of $0.93 in the tangible book value per share of our common stock of existing shareholders and an immediate dilution of $11.21 in the tangible book value per share of our common stock to investors purchasing shares in this offering, or approximately 44.9% of the assumed initial public offering price of $25.00 per share.
The following table illustrates the calculation of the amount of dilution per share that a purchaser of our common stock in this offering will incur given the assumptions discussed above:
Assumed initial public offering price per share |
$ | 25.00 | |||||
Tangible book value per share at June 30, 2017 |
$ | 12.86 | |||||
Increase in tangible book value per share of common stock attributable to new investors purchasing shares in this offering |
$ | 0.93 | |||||
| | | | | | | | |
Pro forma tangible book value per share upon completion of this offering |
$ | 13.79 | |||||
| | | | | | | | |
Dilution per share to new investors in this offering |
$ | 11.21 | |||||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
A $1.00 increase (decrease) in the assumed initial public offering price of $25.00 per share, which is the midpoint of the price range on the cover page of this prospectus, would increase (decrease) the tangible book value of our common stock by $2.2 million, or $0.09 per share, and the dilution to new investors would increase to $12.12 per share or decrease to $10.31 per share, as the case may be, assuming no change to the number of shares offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and estimated offering expenses payable by us.
If the underwriters exercise in full their option to purchase additional shares, the pro forma tangible book value after giving effect to this offering would be $13.92 per share. This represents an increase in tangible book value of $1.06 per share to existing shareholders and dilution of $11.08 per share to new investors.
The following table summarizes, as of June 30, 2017, the total consideration paid to us and the average price per share paid by existing shareholders and investors purchasing common stock in this offering. This information is presented on a pro forma basis after giving effect to the sale of shares of common stock in this offering (assuming the underwriters do not exercise their option to purchase additional shares) at an assumed initial public offering price of $25.00 per share, which is the
59
midpoint of the price range on the cover page of this prospectus, before deducting underwriting discounts and estimated offering expenses payable by us.
| |
Shares Purchased/ Issued |
|
|
|
||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Total Consideration | |
||||||||||||||
| |
Average Price Per Share |
|||||||||||||||
| |
Number | Percent | Amount | Percent | ||||||||||||
| |
|
|
(in millions) |
|
|
|||||||||||
Existing shareholders as of June 30, 2017 |
22,063,072 | 90.2 | % | $ | 278.7 | 82.3 | % | $ | 12.63 | |||||||
New investors in this offering |
2,400,000 | 9.8 | % | $ | 60.0 | 17.7 | % | $ | 25.00 | |||||||
| | | | | | | | | | | | | | | | | |
Total |
24,463,072 | 100 | % | $ | 338.7 | 100 | % | $ | 13.85 | |||||||
In addition, if the underwriters' option to purchase additional shares is exercised in full, the number of shares of common stock held by existing shareholders will be further reduced to 88.9% of the total number of shares of common stock to be outstanding upon the completion of this offering, and the number of shares of common stock held by investors participating in this offering will be further increased to 2,760,000 shares, or 11.1% of the total number of shares of common stock to be outstanding upon the completion of this offering.
The number of shares of our common stock to be outstanding after this offering is based on 22,063,072 shares of common stock outstanding as of June 30, 2017 and excludes (i) 600,000 shares that will be reserved for issuance under our CBTX, Inc. 2017 Omnibus Incentive Plan and (ii) 157,314 and 138,000 shares issuable upon the exercise of outstanding options under our VB Texas, Inc. 2006 Stock Option Plan, or the 2006 Plan, and CBFH, Inc. 2014 Stock Option Plan, or the 2014 Plan, respectively. To the extent that the outstanding but unexercised options under our equity compensation plans are exercised or other equity awards are issued under our equity compensation plans, investors participating in this offering will experience further dilution. We may choose to raise additional capital through the sale of equity or convertible debt securities due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent we issue additional shares of common stock or other equity or convertible debt securities in the future, there will be further dilution to investors participating in this offering.
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PRICE RANGE OF OUR COMMON STOCK
Prior to this offering, our common stock has not been traded on an established public trading market and quotations for our common stock were not reported on any market. As a result, there has been no regular market for our common stock. Although our shares may have been sporadically traded in private transactions, the prices at which such transactions occurred may not necessarily reflect the price that would be paid for our common stock in an active market. As of October 19, 2017, there were approximately 836 holders of record of our common stock.
We anticipate that this offering and the listing of our common stock on the Nasdaq Global Select Market will result in a more active trading market for our common stock. However, we cannot assure you that a liquid trading market for our common stock will develop or be sustained after this offering. You may not be able to sell your shares quickly or at the market price if trading in our common stock is not active. See "Underwriting" for more information regarding our arrangements with the underwriters and the factors considered in setting the initial public offering price.
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Our Company
We are a bank holding company that operates through our wholly-owned subsidiary, CommunityBank of Texas, in Houston and Beaumont, Texas. We focus on providing commercial banking solutions to local small and mid-sized businesses and professionals in our markets. Our market expertise, coupled with a deep understanding of our customers' needs, allows us to deliver tailored financial products and services. As of June 30, 2017, we had total assets of $2.9 billion, total loans of $2.2 billion, total deposits of $2.5 billion and total shareholders' equity of $372.0 million.
Our vision and focus is to continue to build a premier business bank that combines the sophisticated banking products of a large financial institution with the personalized service of a community bank. Our management team and board of directors, led by our Chairman, President and Chief Executive Officer, Robert R. Franklin, Jr., have extensive commercial banking experience as well as long-term relationships and deep ties in the markets we serve. We believe that our future growth and profitability will be predicated on the successful execution of our relationship-driven business model and our ongoing commitment to understanding and meeting the needs of our customers. In addition, we expect that recent investments in our infrastructure and the hiring of additional experienced banking professionals will facilitate growth and increased profitability. While we are primarily focused on organic growth, we plan to pursue strategic acquisitions as an additional means of increasing scale, profitability and shareholder value.
Our History and Growth
We are a Texas corporation that was incorporated on January 26, 2007. We were originally founded by a group of Beaumont business and community leaders, including Pat Parsons as our Chief Executive Officer. We began operations in 2007 with the acquisition of CountyBank, N.A., an institution with $130 million in assets with operations in Beaumont and surrounding counties. Mr. Parsons and our other founders envisioned a community bank in Beaumont committed to creating long-term relationships with small and mid-sized businesses and professionals. Our management and board had a long-term strategic vision to expand the Bank's presence west into Houston through strategic acquisitions, hiring experienced banking professionals, and focused de novo branching.
Today, our company reflects the successful execution of our vision, as we have built and expanded into the attractive Houston market and have added experience and depth to our leadership team. Our merger and acquisition and expansion history includes the following:
62
Franchise Expansion and Market Extension
The following illustrations reflect the transformation of our loan portfolio from year-end 2009 through June 30, 2017 and highlight our successful expansion into the Houston market.
We have utilized our strategic mergers to add valuable members to our team, including to our executive management team. Our current Chairman, President and Chief Executive Officer, Robert R. Franklin, Jr., Chief Financial Officer, Robert "Ted" Pigott, Jr., Chief Credit Officer, Joe F. West and Chief Risk Officer, James L. Sturgeon, joined us through our merger of equals with VB Texas, Inc. In addition, we believe we have been successful in our mergers in retaining key personnel throughout our organization, including in key areas such as lending, human resources and compliance.
In addition to mergers and acquisitions, we have strategically added to our branch footprint by opening de novo locations around teams of seasoned lenders with a realistic plan to achieve branch profitability in a short period of time. We intend to continue to seek out experienced lenders and lending teams around whom we will build necessary infrastructure, including de novo branches if appropriate, to facilitate such lenders' success and integration into our franchise.
We are focused on controlled, profitable growth. Our track record demonstrates this ability, as illustrated in the following chart. Since December 31, 2009, our total assets increased from approximately $1.3 billion to approximately $2.9 billion as of June 30, 2017, and our return on average assets improved from 0.16% for the year ended December 31, 2009 to 1.08% for the six months ended June 30, 2017. We believe that there are significant ongoing growth opportunities for us in our markets.
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Assets and Earnings Growth
(Dollars in millions)
Our Competitive Strengths
We believe our competitive strengths include the following:
Deep and Experienced Management Team. Our Chairman, President and Chief Executive Officer, Robert R. Franklin, Jr., our Vice Chairman Pat Parsons, and our Chief Financial Officer, Robert "Ted" Pigott, Jr., have more than 115 years of combined experience acquiring, growing, operating and selling banks within our markets. Certain biographical information for our selected senior executives is as follows:
Robert R. Franklin, Jr., Chairman, President and Chief Executive Officer. Mr. Franklin began his 36-year Houston banking career working for a small community bank in Houston upon graduation from the University of Texas. He then moved to a large, regional bank before gravitating back to his primary interest of community banking. He became President of American Bank in 1988 where he served until the bank was sold to Whitney Holding Corp. in early 2001. Mr. Franklin and his team then joined Horizon Capital Bank where Mr. Franklin raised sufficient capital to match the bank's existing capital and took the position of President. He served as President until the bank was sold to Cullen/Frost Bankers, Inc. in 2005. Mr. Franklin then started VB Texas, Inc. in November of 2006 as Chairman, President and Chief Executive Officer, serving until a "merger of equals" between VB Texas, Inc. and CBTX, Inc. in 2013, where he currently serves as Chairman, President and Chief Executive Officer.
Pat Parsons, Vice Chairman of the Board. Mr. Parsons has 44 years of banking experience and served as the founding Chairman and Chief Executive Officer of CommunityBank of Texas, and the President and Chief Executive Officer of CBTX, Inc. for seven years. He began his banking career in 1973 with First City National Bank of Houston as a Management Trainee and has served in various capacities at numerous commercial banks within our market areas, including Community Bank & Trust, SSB, as President and Chief Operating Officer. From 1992 to 2004, Mr. Parsons oversaw Community Bank & Trust, SSB's expansion, through organic growth and five acquisitions, to over $1.1 billion in assets and a network spanning 15 Southeast Texas communities. In 2004, Community Bank & Trust, SSB was acquired by Texas Regional Bancshares, Inc.
Robert "Ted" Pigott, Jr., Chief Financial Officer. Mr. Pigott has over 35 years of commercial banking experience, having served as Chief Financial Officer for both privately held and publicly-traded Texas banking institutions in the Houston, Dallas/Fort Worth, Austin and McAllen markets, including Texas Regional Bancshares, Inc. Mr. Pigott joined VB Texas, Inc. as Chief Financial Officer in 2010 and became our Chief Financial Officer in 2013 following the merger of CBTX, Inc. and VB Texas, Inc. He also spent six years in public accounting with Arthur Andersen & Co., a national accounting firm.
64
The Bank is managed by an executive committee consisting of ten highly qualified and experienced bankers with an average of 38 years of banking experience. The members of the executive committee oversee various aspects of our organization including lending, credit administration, treasury services, finance, operations, information technology, regulatory compliance and risk management. Additionally, we have four regional CEOs with an average of 27 years of banking experience who oversee loan and deposit production and performance in their respective markets. Our team has a demonstrated track record of achieving profitable growth, maintaining a strong credit culture, implementing a relationship-driven approach to banking and successfully executing acquisitions.
We believe our continued growth and success will benefit from a commitment to developing our next generation of bankers. Our commitment to talent development includes a mentorship program, which provides our junior bankers with an opportunity to take a hands-on approach to interacting with our customers and learning directly from our successful senior banking team members. We also provide formal in-house training for our junior bankers, which enhances their professional experience, and provides for greater organic growth opportunities and employee retention. We believe that our commitment to the development of talent leads to long-term continuity and the recruitment and retention of high quality bankers in our markets. These aspects lay the foundation for the long-term growth potential of the Bank.
Strength of Our Operating Markets. As further described in "Our Market Areas" below, we believe that our two primary markets provide us with an advantage over other community banks in Texas in terms of growing our loans and deposits, as well as increasing profitability and building shareholder value. Houston is the fastest growing major MSA in the country measured by population growth. With an estimated population of approximately 7.0 million people living in a diverse economy with a robust job market, we believe it is one of the most dynamic banking markets in the country. Our management, team of lenders and well positioned branch network should afford us the ability to capitalize on the projected growth in the Houston MSA.
Our team's history of operating successful banking institutions in the Beaumont market spans decades, and we have a strong reputation for delivering superior service in the market. Our deep ties to the community have led to a dominant market share, and we are ranked number one in deposits in the Beaumont-Port Arthur MSA, with over 20% market share as of June 30, 2017. Our branches in the Beaumont-Port Arthur MSA provide a stable, low-cost core funding base of approximately $1.1 billion in deposits.
True Relationship-Based Community Banking. We believe that banking is a profession, and we expect our bankers to be more than just salesmen. With an active knowledge of our markets and skilled analytical capabilities, our bankers serve as financial partners to our customers, helping them to grow their businesses. We strive to provide complete and comprehensive loan and deposit options to our customers, and we believe that the most effective way to win business is to develop relationships with our customers by spending time with them at their places of business. Our bankers make these customer visits a priority, and we take a team-based approach by including treasury services professionals and senior management on many customer meetings. Our bankers strive to gain a comprehensive understanding of how our customers' businesses operate, which helps us craft financial solutions to fulfill their needs. We are active and diligent in this effort to organically source business, as we believe it allows us to be more selective in our approach to lending. As a testament to our relationship approach to banking, as of June 30, 2017, approximately 83% of our loan customers also have deposit relationships with us.
Growing Core Deposit Franchise. Noninterest-bearing deposits represented 40.96% of our total deposits as of June 30, 2017, and our cost of deposits was 0.30% for the first six months of 2017. Developing low-cost deposit relationships with our business customers is a key component of our growth strategy. Our strong deposit base serves as a major driver of our operating results, as we utilize
65
our core deposits primarily to fund our loan growth. We believe that our relationship-based approach to banking, combined with our ability to offer a full suite of sophisticated treasury services, enhances our ability to source low-cost, core deposits to fund organic growth.
Maintain Strong Asset Quality. Preserving sound credit underwriting standards as we grow our loan portfolio will continue to be integral to our strategy. We place a considerable emphasis on effective risk management as an essential component of our organizational culture. We use our risk management infrastructure to monitor existing operations, support decision-making and improve the success rate of new initiatives. To maintain strong asset quality, we employ centralized and thorough loan underwriting, a diversified loan portfolio and highly experienced credit officers and credit analysts, including two Regional Credit Officers, one for each of our primary markets. We believe the long-term success of our business hinges on maintaining sound credit quality. Our nonperforming assets to total assets ratio was 0.52% as of December 31, 2015, 0.27% as of December 31, 2016 and 0.33% as of June 30, 2017.
Proven Ability to Acquire and Integrate Banks. We have completed five whole-bank acquisitions and, as a result, we believe we have developed an experienced and disciplined acquisition and integration approach capable of identifying candidates, conducting thorough due diligence, determining financial attractiveness and integrating the acquired institution. We believe that we have built a corporate infrastructure capable of supporting additional continued growth both organically and through strategic acquisitions. Our acquisition experience and our reputation as a successful acquirer should position us well to capitalize on additional opportunities in the future.
Our Banking Strategy
Our executive management team and board of directors have focused on building a premier banking franchise that is capable of yielding sustainable growth and long-term profitability that enhances value for our shareholders, which we intend to accomplish through:
Strong Credit Culture. Our approach to credit begins with a thorough understanding of our customers' businesses. When underwriting a potential lending opportunity, we analyze our customer's balance sheet with a focus on liquidity, and the income statement with emphasis on cash flow and the cash cycle of the business. Additionally, we receive personal guarantees from the principal or principals on the majority of our commercial credits. All credit relationships greater than $1.0 million must be approved by our internal loan committee, and all credit relationships greater than $2.5 million must be approved by the Bank's active Directors Loan Committee, which meets twice per week.
Our credit officers are involved in the underwriting structuring and pricing process at inception of the lending opportunity and remain involved through approval. We manage risk in the portfolio with prudent underwriting and proactive credit administration, utilizing a Regional Credit Officer and credit analysts located in each of our two primary markets. Furthermore, we believe our individual lending authority is low relative to our peers. This combined with the Bank's active Directors Loan Committee allows us to maintain centralized underwriting, which we believe gives us consistency across our loan portfolio and allows us to be responsive to our customers' timing needs.
Diversified Loan Portfolio. Our focus on lending to small to medium-sized businesses and professionals in our market areas results in a diverse loan portfolio comprised primarily of core relationships, where our bankers support clients through tailored financial solutions. Additionally, we carefully monitor exposure to certain asset classes to minimize the impact of a downturn in the value of such assets. Finally, we are currently expanding our commercial and industrial, medical and SBA lending products as we see an attractive opportunity and believe this will further diversify our loan portfolio across lending verticals.
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Comprehensive Suite of Financial Solutions. We provide a comprehensive suite of financial solutions that competes with large, national competitors, but with the personalized attention and nimbleness of a relationship-focused community bank. We offer a full range of banking products, including commercial and industrial loans (including equipment loans and working capital lines of credit), commercial real estate loans (including owner-occupied and investor real estate loans, construction and development loans), SBA loans, treasury services and commercial deposits. Other banking products we offer include traditional retail deposits, mortgage origination and online banking. We have recently expanded our treasury services platform by hiring additional personnel in order to more effectively provide treasury services solutions to our customers. We believe our clients prefer to obtain their banking services from local institutions able to provide the sophistication of larger banks, but with a local and agile decision-making process, personal connections, and an interest in investing in the local economy and community. This also allows us to gather core, low-cost deposit relationships, high credit quality loans and fee income generated by value-added services.
Organic Growth. We aim to continuously enhance our customer base, increase loans and deposits and expand our overall market share, and believe that Houston specifically has significant organic growth opportunities. Through the successful implementation of our relationship-driven, community banking strategy, a significant portion of our organic growth has been through referral business from our current customers and professionals in our markets including attorneys, accountants and other professional service providers. We plan to continue our organic growth by leveraging the extensive experience of our board of directors, executive management team and senior bankers, all of which give us market insight and familiarity with our customers. By understanding our customers' businesses, appropriately structuring our loans, and applying a solution-minded approach and attitude to our customers' needs, we believe that we will continue to attract customers who value our approach of being their financial partners. Our team of seasoned bankers has been, and will continue to be, an important driver of our organic growth by further developing banking relationships with current and potential customers.
We have a track record of hiring experienced bankers to enhance our organic growth, and sourcing and hiring talent will continue to be a core focus for us. We believe that this initial public offering will enhance our ability to attract and retain this talent. We have identified areas of opportunity within certain lending verticals and plan to hire additional bankers to focus on these efforts. While we currently offer commercial and industrial, medical and SBA lending products, we have recently added bankers focused on these products in order to expand these verticals.
Strategic Acquisitions. We intend to continue to supplement our organic growth through strategic acquisitions, and we believe obtaining a publicly-traded common stock will improve our ability to compete for these opportunities. Many small to medium-sized banking organizations face significant scale and operational challenges, regulatory pressure, management succession issues and shareholder liquidity needs. Although we have no current plans, arrangements or understandings to make any material acquisitions, we expect our markets will afford us opportunities to identify and execute acquisitions designed to strengthen our franchise and increase shareholder value. In addition to meeting our financial thresholds, we place critical importance on the target contributing meaningful strategic enhancements, including talented bankers that will be additive to our franchise, a sound credit culture and a complementary branch footprint.
Increase Operational Efficiency. We are focused on improving our operational efficiency and expect these efforts to drive future profitability and increase shareholder value. We have upgraded our operating capabilities and created a platform for continued efficiencies in the areas of risk management, technology, data processing, regulatory compliance and human resources that is capable of handling our continued growth, which we believe will help us to achieve increased scale without incurring significant incremental noninterest expense. In addition, we have streamlined our branch
67
footprint by closing three smaller branches and utilizing our central Houston location. This centralized corporate lending structure combined with our robust treasury services, which has led to approximately 83% of our loan customers having deposit relationships with us as of June 30, 2017, provides us with a more efficient path to profitable growth. Our efficiency ratio has improved from 67.8% for the year ended December 31, 2012, to 62.7% for the year ended December 31, 2016, and was 62.8% for the six months ended June 30, 2017.
Our net income increased from $11.4 million in 2012 to $27.2 million in 2016, for a CAGR of 24.2%, and our return on average assets improved from 0.74% in 2012 to 0.94% in 2016. For the six months ended June 30, 2017, our net income was $15.6 million compared to $12.9 million for the six months ended June 30, 2016, and our return on average assets improved to 1.08% from 0.92% over the same time periods, respectively.
In addition to continued improvements in our operational efficiencies, we expect our profitability to increase in a rising interest rate environment due to our asset-sensitive balance sheet, which has resulted from our focus on commercial and industrial lending and the quality of our deposit franchise. As of June 30, 2017, 58.3% of our loans had a variable interest rate, and we believe we are well positioned to experience net interest margin expansion in a rising rate environment.
Our Market Areas
We classify our branch footprint in two primary market areas, Houston and Beaumont. We have 18 branches located in Houston, and our Beaumont presence, concentrated in Southeast Texas, includes 16 branches.
Houston Metropolitan Area
The Houston MSA is comprised of nine counties spanning over nine thousand square miles. The Houston MSA has the fifth largest population nationwide based on estimated 2018 population statistics provided by Nielsen. Houston is poised for continued robust growth, and ranks first for projected five-year population growth through 2023 among the 25 largest MSAs in the United States, according to Nielsen. According to the Greater Houston Partnership, Houston's 2015 gross domestic product, or GDP, of $503 billion ranks it as the fourth largest economy in the United States and would rank it as the 26th largest economy for a country in the world.
| |
|
Population (millions) | |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
Top 5 Growth Growth Rank |
Top 5 Large MSAs by Population Growth | 2018 Estimated |
2023 Projected |
Population % D |
||||||||
1 |
Houston-The Woodlands-Sugar Land, TX | 7.0 | 7.6 | 8.3 | % | |||||||
2 |
Orlando-Kissimmee-Sanford, FL | 2.5 | 2.7 | 8.2 | % | |||||||
3 |
San Antonio-New Braunfels, TX | 2.5 | 2.7 | 8.1 | % | |||||||
4 |
Dallas-Fort Worth-Arlington, TX | 7.4 | 8.0 | 7.7 | % | |||||||
5 |
Denver-Aurora-Lakewood, CO | 2.9 | 3.2 | 7.7 | % | |||||||
|
Texas | 28.5 | 30.6 | 7.1 | % | |||||||
|
Nationwide | 326.5 | 337.9 | 3.5 | % | |||||||
We believe that our 18 branches are strategically located throughout Houston, which will help drive loan growth and improve deposit market share as we execute our strategy.
Attractive Business Climate. The favorable business environment in Texas includes a large and growing workforce, low business tax, no personal income tax and a reasonable cost of housing, which has resulted in business relocation to the state, and to Houston, in particular. Houston is the home of 20 Fortune 500 companies.
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Sizable Workforce and Diverse Job Market. According to the Greater Houston Partnership, there are approximately three million jobs in Houston, which is greater than 35 states combined. While energy companies contribute significantly to Houston's GDP, the economy in Houston has become more diverse over the last three decades and several industries contribute to the economy's growth and diversification. Major industries for employment include energy, healthcare, transportation, manufacturing, education and finance. The Texas Medical Center is the world's largest medical complex, with industry leading specialties in research and treatment for cancer and cardiovascular disease. Growth of the medical center remains robust and there are currently approximately $3 billion in medical construction projects underway.
Strategic Location. Houston's location in the South Central U.S. along the Gulf of Mexico provides businesses and individuals with unmatched access to all modes of transportation and a centralized location with efficient access to other areas of the country. In 2015, the Port of Houston ranked first in both export and import tonnage among all U.S. ports, and second in total tonnage, according to the Greater Houston Partnership. Houston also boasts two international airports which offered non-stop flights to 124 domestic destinations and 74 international destinations in 2016. In 2015, the Houston Airport System processed over 441 metric tons of air freight and served over 55 million travelers, according to the Greater Houston Partnership.
Beaumont Market Area
Our deep ties to the Beaumont area and long history of providing tailored financial products and services have led us to become the market share leader in the Beaumont-Port Arthur MSA in terms of deposits, with over 20% market share as of June 30, 2017. Our branches in this market, which is located adjacent to Houston, approximately 85 miles east of downtown Houston, provide a stable, low-cost core funding base of approximately $1.1 billion in deposits. Our Beaumont footprint includes 12 branches located in Beaumont and four located in its surrounding areas.
The cities of Beaumont, Port Arthur and Orange are all located in the Beaumont-Port Arthur MSA and form what is known as the "Golden Triangle," a major industrial and petrochemical complex located on the Gulf of Mexico, according to Forbes. Other leading industries in the market include transportation, defense and education. Petrochemical production and processing has grown significantly along the Gulf of Mexico in recent years, as six of the eight new U.S. ethylene projects under construction are being built on the Texas Gulf Coast, according to the Beaumont Enterprise. Beaumont has benefitted from the growth in the industry, as ExxonMobil recently announced the expansion of its Beaumont polyethylene plant by 65%, which is expected to add 1,400 jobs to the local economy.
Our Banking Services
Lending Activities
We offer a variety of loans, including commercial and industrial, commercial real estate-backed loans (including loans secured by owner-occupied commercial properties), commercial lines of credit, working capital loans, term loans, equipment financing, acquisition, expansion and development loans, borrowing base loans, construction and development loans, homebuilder loans, agricultural loans, SBA loans, letters of credit and other loan products to small and medium-sized businesses, real estate developers, mortgage lenders, manufacturing and industrial companies and other businesses. We also offer various consumer loans to individuals and professionals including residential real estate loans, home equity loans, home equity lines of credit, or HELOCs, installment loans, unsecured and secured personal lines of credit, overdraft protection and letters of credit. Lending activities originate from the relationships and efforts of our bankers, with an emphasis on providing banking solutions tailored to meet our customers' needs while maintaining our underwriting standards.
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For additional information concerning our loan portfolio, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Loan Portfolio."
Concentrations of Credit Risk. Most of our lending activity is conducted with businesses and individuals in our Houston and Beaumont markets. Our loan portfolio consists primarily of commercial and industrial loans, which were $535.1 million and constituted 24.4% of our total loans as of June 30, 2017, and commercial real estate and multi-family loans, which were $898.3 million and constituted 40.9% of our total loans as of June 30, 2017. Our commercial real estate and multi-family loans are generally secured by first liens on real property. Our commercial and industrial loans are typically secured by general business assets, accounts receivable, inventory, and/or the corporate guaranty of the borrower and personal guaranty of its principals. The geographic concentration subjects the loan portfolio to the general economic conditions within Texas and, in particular, our Houston and Beaumont markets. The risks created by such concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses. Management believes the allowance for loan losses is adequate to absorb incurred losses in our loan portfolio as of June 30, 2017.
Sound risk management practices and appropriate levels of capital are essential elements of a sound commercial real estate lending program. Concentrations of commercial real estate exposures add a dimension of risk that compounds the risk inherent in individual loans. Interagency guidance on commercial real estate concentrations describe sound risk management practices which include board and management oversight, portfolio management, management information systems, market analysis, portfolio stress testing and sensitivity analysis, credit underwriting standards, and credit risk review functions. Management believes it has implemented these practices in order to monitor concentrations in commercial real estate in our loan portfolio.
Large Credit Relationships. As of June 30, 2017, our 15 largest loan relationships (including related entities) totaled approximately $255.9 million in loans, or 10.3% of the total loan portfolio. See "Risk Factors—Risks Related to Our Business—Our largest loan relationships currently make up a material percentage of our total loan portfolio."
Loan Underwriting and Approval. Historically, we believe we have made sound, high quality loans while recognizing that lending money involves a degree of business risk. We have loan policies designed to assist us in managing this business risk. These policies provide a general framework for our loan origination, monitoring and funding activities, while recognizing that not all risks can be anticipated. Our board of directors delegates loan authority up to board-approved hold limits collectively to our active Directors Loan Committee, which is comprised of members of our board of directors. Our board of directors also delegates limited lending authority to our internal loan committee, which is comprised of the following members of our executive management team: Chief Executive Officer, Vice Chairman, President, Chief Credit Officer, credit risk personnel, and, on a further limited basis, to selected lending managers in each of our target markets. Lending officers and relationship managers, including our bankers, have further limited individual loan authority. When the total relationship exceeds an individual's loan authority, a higher authority or credit committee approval is required. The objective of our approval process is to provide a disciplined, collaborative approach to larger credits while maintaining responsiveness to client needs.
Loan decisions are documented as to the borrower's business, purpose of the loan, evaluation of the repayment source and the associated risks, evaluation of collateral, covenants and monitoring requirements, and the risk rating rationale. Our strategy for approving or disapproving loans is to follow conservative loan policies and consistent underwriting practices which include:
- •
- granting credit on a sound basis with full knowledge of the purpose and source of repayment for such credit;
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- •
- ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan;
- •
- developing and maintaining targeted levels of diversification for our loan portfolio as a whole and for loans within each category; and
- •
- ensuring that each loan is properly documented and that any insurance coverage requirements are satisfied.
Managing credit risk is an enterprise-wide process. Our strategy for credit risk management includes well-defined, centralized credit policies, uniform underwriting criteria and ongoing risk monitoring and review processes for all credit exposures. Our processes emphasize early-stage review of loans, regular credit evaluations and management reviews of loans, which supplement the ongoing and proactive credit monitoring and loan servicing provided by our bankers. Our Chief Credit Officer provides company-wide credit oversight and reviews credit risk portfolios as economic conditions or portfolio health dictate to ensure that the risk identification processes are functioning properly and that our credit standards are followed. In addition, a third-party loan review is performed to assist in the identification of problem assets and to confirm our internal risk rating of loans. We also maintain close relationships with our customers, which allows the responsible banker an opportunity to engage in ongoing credit monitoring and loan servicing. We attempt to identify potential problem loans early in an effort to seek aggressive resolution of these situations before the loans become a loss, record any necessary charge-offs promptly and maintain adequate allowance levels for probable loan losses inherent in the loan portfolio.
Our loan policies generally include other underwriting guidelines for loans collateralized by real estate. These underwriting standards are designed to determine the maximum loan amount that a borrower has the capacity to repay based upon the type of collateral securing the loan and the borrower's income. Such loan policies include maximum amortization schedules and loan terms for each category of loans collateralized by liens on real estate.
In addition, our loan policies provide guidelines for personal guarantees; an environmental review; loans to employees, executive officers and directors; problem loan identification; maintenance of an adequate allowance for loan losses and other matters relating to lending practices.
Lending Limits. Our lending activities are subject to a variety of lending limits imposed by federal law. In general, the Bank is subject to a legal lending limit on loans to a single borrower based on the Bank's capital level. The dollar amounts of the Bank's lending limit increases or decreases as the Bank's capital increases or decreases. The Bank is able to sell participations in its larger loans to other financial institutions, which allows it to manage the risk involved in these loans and to meet the lending needs of its customers requiring extensions of credit in excess of these limits.
The Bank's legal lending limit as of June 30, 2017 on loans to a single borrower was $51.0 million, and will increase following the consummation of this offering. However, we typically maintain an in-house limit of $25 million for loans to a single borrower. While in some cases, we may make loans that exceed the in-house limits if approved by our Directors Loan Committee, as discussed further below, we have strict policies and procedures in place for the establishment of hold limits with respect to specific products and businesses and evaluating exceptions to the hold limits for individual relationships.
Our loan policies provide general guidelines for loan-to-value ratios that restrict the size of loans to a maximum percentage of the value of the collateral securing the loans, which percentage varies by the type of collateral. Our internal loan-to-value limitations follow limits established by applicable law.
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Loan Types. At June 30, 2017, we had total loans of $2.2 billion representing 74.6% of our total assets. We provide a variety of loans to meet our customers' needs and the table and section below discusses our general loan categories as of June 30, 2017:
| |
As of June 30, 2017 | ||||||
|---|---|---|---|---|---|---|---|
(Dollars in thousands) Loan Type |
Amount | Percent | |||||
Commercial and industrial |
$ | 535,116 | 24.4 | % | |||
Commercial real estate and multi-family |
898,266 | 40.9 | % | ||||
Construction and development |
433,966 | 19.8 | % | ||||
1-4 family residential |
240,073 | 10.9 | % | ||||
Consumer, agriculture and other |
90,017 | 4.0 | % | ||||
| | | | | | | | |
Gross loans |
$ | 2,197,438 | 100.0 | % | |||
Less deferred fees and unearned discount |
4,436 | ||||||
Less loans held for sale |
559 | ||||||
Total loans |
$ | 2,192,443 | |||||
Our commercial loan portfolio includes commercial and industrial, commercial real estate and multi-family, and construction and development loans. The $1.9 billion commercial loan portfolio represents approximately 85% of gross loans and the following chart presents a detailed composition of those loans as of June 30, 2017.
Commercial and Industrial Loans. We make commercial and industrial loans, including commercial lines of credit, working capital loans, term loans, equipment financing, acquisition, expansion and development loans, borrowing base loans, restaurant franchisees, SBA loans, letters of
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credit and other loan products, primarily in our target markets, that are underwritten on the basis of the borrower's ability to service the debt from income. We take as collateral a lien on general business assets including, among other things, available real estate, accounts receivable, inventory and equipment and generally obtain a personal guaranty of the borrower or principal. Our commercial and industrial loans generally have variable interest rates and terms that typically range from one to five years depending on factors such as the type and size of the loan, the financial strength of the borrower/guarantor and the age, type and value of the collateral. Fixed rate commercial and industrial loan maturities are generally short-term, with three- to five-year maturities, or include periodic interest rate resets. Terms greater than five years may be appropriate in some circumstances, based upon the useful life of the underlying asset being financed or if some form of credit enhancement, such as an SBA guarantee, is obtained. As of June 30, 2017, we had $48.9 million of commercial and industrial loans due after five years. These loans had a weighted average maturity of approximately 7.5 years.
In general, commercial and industrial loans may involve increased credit risk and, therefore, typically yield a higher return. As a result of these additional complexities, variables and risks, commercial and industrial loans require extensive underwriting and servicing.
Commercial Real Estate and Multi-Family Loans. We make commercial mortgage loans collateralized by real estate, which may be owner-occupied or non-owner-occupied real estate, as well as multi-family residential loans. Commercial real estate lending typically involves higher loan principal amounts and the repayment is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. We require our commercial real estate loans to be secured by well-managed property with adequate margins and generally obtain a guaranty from responsible parties. Our commercial mortgage loans are generally collateralized by first liens on real estate, have variable or fixed interest rates and typically amortize over a 10-to-20 year period with balloon payments or rate adjustments at the end of three to seven years.
Our multi-family residential loan portfolio is comprised of loans secured by properties deemed multi-family, which includes apartment buildings. Our multi-family residential loan portfolio is primarily comprised of and collateralized by Texas-based community development and affordable housing projects and is the result of the conversion of construction and development loans on such projects into permanent loans upon the successful completion of projects. Repayment is largely based on the successful management of the project and the success of leasing the units and the terms of the loans generally can vary up to between 30 to 35 years.
Construction and Development Loans. We make loans to finance the construction of residential and non-residential properties. Construction and development loans generally are collateralized by first liens on real estate and generally have floating interest rates. We conduct periodic inspections, either directly or through an agent, prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described above also are used in our construction and development lending activities. Our construction and development loans typically have terms that range from six months to two years depending on factors such as the type and size of the development and the financial strength of the borrower/guarantor. Loans are typically structured with an interest only construction period. Loans are underwritten to either mature at the completion of construction, or transition to a traditional amortizing commercial real estate facility at the completion of construction, the terms and characteristics of which are generally in line with other commercial real estate loans we hold in our portfolio.
1-4 Family Residential. We originate residential mortgages to be held for investment or for sale into the secondary market through the mortgage division of our Bank. We have developed a scalable platform for mortgage originations within this division and believe that we have significant opportunities to grow the business. The mortgage division handles loan processing, underwriting and closings in-house. Typically, loans with a fixed interest rate of greater than 10 years are sold on the
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secondary market, and adjustable rate mortgages are held for investment. Loans sold are subject to certain indemnification provisions with investors, including the repurchase of loans sold and the repayment of sales proceeds to investors under certain conditions. In addition, if a customer defaults on a mortgage payment shortly after the loan is originated, the purchaser of the loan may have a put right, whereby they can require us to repurchase the loan at the full amount paid by the purchaser. Loans collateralized by 1-4 family residential real estate generally are originated in amounts of no more than 80% of appraised value. Home equity loans and HELOCs are generally limited to a combined loan-to-value ratio of 80%, including the subordinate lien. We retain a valid lien on real estate, obtain a title insurance policy that insures that the property is free from encumbrances and require hazard insurance.
From time to time we have purchased residential mortgages in our primary market areas originated by other financial institutions to hold for investment with the intent to diversify our residential mortgage loan portfolio, meet certain regulatory requirements and increase our interest income. These loans purchased typically have a fixed rate with a term of 15 to 30 years, and are collateralized by 1-4 family residential real estate. We have a defined set of credit guidelines that we use when evaluating these credits. Although these loans were originated and underwritten by another institution, our mortgage and credit departments conduct an independent review of these loans. As of June 30, 2017, we had balances of $14.2 million in purchased residential real estate mortgages. At June 30, 2017, all of the residential mortgages purchased were performing in accordance with their contractual terms.
Consumer and Other Loans. We make a variety of loans to individuals for personal and household purposes, including secured and unsecured term loans and home improvement loans. Consumer loans are underwritten based on the individual borrower's income, current debt level, past credit history and the value of any available collateral. The terms of consumer loans vary considerably based upon the loan type, nature of collateral and size of the loan. We also make loans to borrowers that in turn provide financing to their clients as part of their businesses. A small portion, approximately 0.4% at June 30, 2017, of our gross loans are agricultural loans. In addition to both fixed rate and adjustable rate agricultural real estate loans, we also make loans to finance the purchase of machinery, equipment, and breeding stock, as well as operating and revolving loans for seasonal crop production and livestock operations.
Credit Policies and Procedures
General. Preserving sound credit underwriting standards as we grow our loan portfolio will continue to be integral to our strategy. We place a considerable emphasis on effective risk management as an essential component of our organizational culture. We use our risk management infrastructure to monitor existing operations, support decision-making and improve the success rate of new initiatives. To maintain strong asset quality, we employ centralized and thorough loan underwriting, a diversified loan portfolio and highly experienced credit officers and credit analysts, including our Chief Credit Officer and two Regional Credit Officers, one located in each of our primary markets.
Our approach to credit begins with a thorough understanding of our customer's business. When underwriting a potential lending opportunity, we analyze our customer's balance sheet with a focus on liquidity, and the income statement with emphasis on cash flow and the cash cycle of the business. Additionally, we receive personal guarantees from the principal or principals on the majority of our commercial credits. Substantially all of our loans are made to borrowers located or operating in our primary market areas with whom we have ongoing relationships across various product lines. We believe that our future growth and profitability will be predicated on the successful execution of our relationship-driven business model and our ongoing commitment to understanding and meeting the needs of our customers.
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Credit Concentrations. In connection with the management of our credit portfolio, we actively manage the composition of our loan portfolio, including credit concentrations. Our management administers a risk-based approach to effectively identify, measure, monitor, mitigate, control and manage concentration risks. The Bank's board of directors establishes capital limits for concentrations based on collateral. Sub-limits within concentration are considered and assessed, when necessary, to mitigate risk. Board-approved limits take into account capital, asset quality earnings, liquidity compliance, competition, reputation and legal considerations. The Bank's board of directors reviews capital limitations, at least annually, or more frequently when dictated by changing conditions. Our Credit Administration Department monitors the levels of concentrations relative to the specified limit approved by the Bank's board of directors.
Loan Approval Process. We maintain a credit culture that actively supports the extension of credit on the basis of sound, fundamental lending principles, and we selectively extend credit for the purpose of establishing long-term relationships with our customers. As of June 30, 2017, the Bank had a legal lending limit of approximately $51.0 million, and our board had established an "in-house" lending limit to any single customer of $25.0 million. Our board evaluates the in-house limit from time to time and adjusts it based on, among other things, its consideration of the Bank's operations, economic conditions and other factors it deems relevant. Additionally, we may make loans that exceed our in-house limit if such loans are approved by our Directors Loan Committee. Our credit approval policies provide for various levels of officer and senior management lending authority for new credits and renewals, which are based on position, capability and experience. We believe our individual lending authority is low relative to our peers. All credit relationships greater than $250,000 must be approved by our Regional Credit Officers. All credit relationships greater than $1.0 million must be approved by our internal loan committee, consisting of the Bank's Chairman of the Board and Chief Executive Officer, President, Vice Chairman of the Board and Senior Credit Officer. Our Directors Loan Committee, which meets twice per week, must approve all credit relationships greater than $2.5 million. These limits are reviewed periodically by the Bank's board of directors. Our credit officers are involved in the underwriting, structuring, and pricing process at inception of the lending opportunity and remain involved through approval, and we believe that our credit approval process provides for thorough underwriting and efficient decision-making.
Credit Risk Management. We manage risk in our portfolio with prudent underwriting and proactive credit administration, utilizing a Regional Credit Officer and credit analysts located in each of our two primary markets. We have lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Our management and board of directors review and approve these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and our board of directors with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in our loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
Our loan review function is designed to ensure the early identification of problem loans. In particular, our loan review policy seeks to provide for (i) the timely identification of potential and existing credit weaknesses in individual loans, significant customer relationships, and within our loan portfolio in general, (ii) the prompt assignment of credit risk grades, where appropriate, and (iii) the maintenance of an adequate allowance for loan loss account by making timely and appropriate provisions for probable, estimated and identifiable losses. Our loan review process involves evaluating credit quality, sufficiency of credit and collateral documentation, proper collateral lien perfections, proper collateral loan approval for new loans and subsequent renewals, formal extensions, restructurings and renegotiations, customer adherence to loan covenants and approved modifications, compliance with our loan policy and applicable laws and regulations, and the accuracy and timeliness of
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credit risk grades being assigned from time to time by our loan officers, our Senior Credit Officer or the Directors Loan Committee.
Our loan review function involves early-stage reviews from all of our loan officers with respect to their assigned portfolios. Our loan officers report problem past due credits to our Senior Credit Officer on a timely basis to allow our management an opportunity to assess whether collection procedures are being adhered to in a consistent manner. Our loan officers are responsible for initiating prompt customer contacts and for thorough review of customer financial statements upon receipt by the Bank, maturing loan reports, delinquent loan reports, customer correspondence, credit and collateral exception reports, and collateral documents and valuation reports. Based on these ongoing reviews and analyses, our loan officers submit recommendations directly to the Bank's President, Senior Credit Officer, or Directors Loan Committee regarding the designation of appropriate credit risk grades for individual loans and customer relationships, as well as recommendations for the upgrading or downgrading of previously adversely-graded loans, where justified.
Our Senior Credit Officer and the Directors Loan Committee have secondary responsibilities for review and analysis of individual loans, customer relationships and our portfolio as a whole. Based upon the periodic review of internally generated bank reports and discussion of information on individual loan customers, our Senior Credit Officer or the Directors Loan Committee will recommend the designation of credit risk grades and upgrades or downgrades, where justified. Final responsibility for loan review and assignment of credit risk grades lies with the Bank's board of directors, which reviews our Watch/Problem Loan List at least quarterly. The Directors Loan Committee and the Bank's board of directors also review loan portfolio composition and customer and industry sector concentrations and verify adherence to established prudent parameters.
We retain an independent third party to review and validate our credit risk program on a periodic basis. Results of these reviews are presented to our management and board of directors. The loan review process supplements the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures. We believe our conservative lending approach and focused management of nonperforming assets has resulted in sound asset quality and timely resolution of problem assets. We have several procedures in place to assist us in maintaining the overall quality of our loan portfolio. We have established underwriting guidelines to be followed by our bankers, and we also monitor our delinquency levels for any negative or adverse trends.
Deposits
Our deposits serve as the primary funding source for lending, investing and other general banking purposes. We provide a full range of deposit products and services, including a variety of checking and savings accounts, certificates of deposit, money market accounts, debit cards, remote deposit capture, online banking, mobile banking, e-Statements, bank-by-mail and direct deposit services. We also offer business accounts and cash management services, including business checking and savings accounts and treasury services. We solicit deposits through our relationship-driven team of dedicated and accessible bankers and through community-focused marketing. We also seek to cross-sell deposit products at loan origination. Our centralized corporate lending structure combined with our robust treasury services has led to approximately 83% of our loan customers having deposit relationships with us as of June 30, 2017.
Developing low-cost, core deposit relationships with our business customers is a key component of our growth strategy. As of June 30, 2017, we held approximately $2.5 billion of total deposits, and from December 31, 2012 to June 30, 2017, our total deposits increased at a compound annual growth rate of approximately 12.7%. Our core deposit to total deposit ratio has ranged from 90.7% as of December 31, 2012 to 92.8% as of June 30, 2017. Our cost of total deposits was 0.30% and
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noninterest-bearing deposits comprised approximately 41.0% of total deposits for the six months ended June 30, 2017.
Our strong deposit base serves as a major driver of our operating results, as we utilize our core deposits primarily to fund our loan growth. We believe that our relationship-based approach to banking, combined with our ability to offer a sophisticated full suite of treasury services, enhances our ability to source low-cost, core deposits to fund organic growth.
Between year-end 2012 and June 30, 2017 we increased deposits by $1.05 billion while, as illustrated in the chart below, decreasing our percentage of time deposits over $100,000 and maintaining our percentage of noninterest-bearing deposits at approximately 40%.
The following table presents the composition of our deposits as of June 30, 2017:
| |
As of June 30, 2017 | ||||||
|---|---|---|---|---|---|---|---|
(Dollars in thousands)
|
Amount | Percent | |||||
Noninterest-bearing deposits |
$ | 1,030,865 | 41.0% | ||||
Interest-bearing demand accounts |
343,826 | 13.7% | |||||
Savings accounts |
88,083 | 3.5% | |||||
Money market accounts |
698,546 | 27.7% | |||||
Certificates and other time deposits, greater than $100,000 |
182,143 | 7.2% | |||||
Certificates and other time deposits, less than $100,000 |
173,321 | 6.9% | |||||
| | | | | | | | |
Total deposits |
$ | 2,516,784 | 100.0% | ||||
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Other Products and Services
We offer competitively priced banking products and services with a focus on customer convenience and accessibility. We offer a full suite of online banking services including access to account balances, online transfers, online bill payment and electronic delivery of customer statements, as well as ATMs,
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and banking by telephone, mail and personal appointment. We also offer debit cards, night depository, direct deposit, cashier's checks and letters of credit, as well as treasury services, including lockbox, wire transfer services, remote deposit capture and automated clearinghouse services.
We are currently focused on expanding noninterest income through increased income from our treasury services, which also serves as an attractive source of core deposits. We offer a full array of commercial treasury services designed to be competitive with banks of all sizes. Treasury services include balance reporting (including current day and previous day activity), transfers between accounts, wire transfer initiation, automated clearinghouse origination and stop payments. We have recently expanded our treasury services platform by hiring additional personnel to provide treasury solutions to our customers more effectively. Treasury services deposit products consist of remote deposit capture, merchant services, positive pay and reverse positive pay (automated fraud detection tools), account reconciliation services, zero balance accounts and sweep accounts, including loan sweep.
Investments
We manage our investment portfolio to provide a source of liquidity, to provide an appropriate return on funds invested, to manage interest rate risk, to meet pledging requirements and to meet regulatory capital requirements. As of June 30, 2017, the amortized cost of our investment portfolio totaled $220.3 million, with an average yield of 2.45% and an estimated modified duration of approximately 4.1 years.
The Bank's board of directors annually reviews the investment policy and has delegated the responsibility of monitoring our investment activities to the Funds Management Committee. Day-to-day activities pertaining to the investment portfolio are conducted within our finance department under the supervision of our Chief Financial Officer.
Information Technology Systems
We continue to make significant investments in our information technology systems for our banking and lending operations and treasury services. We believe that these investments are essential to enhance our capabilities to offer new products and overall customer experience, to provide scale for future growth and acquisitions, and to increase controls and efficiencies in our back-office operations. We have obtained our core data processing platform from a nationally recognized bank processing vendor providing us with capabilities to support the continued growth of the Bank. Our internal network and e-mail systems are maintained in-house. We leverage the capabilities of a third-party service provider to provide the technical expertise around network design and architecture that is required for us to operate as an effective and efficient organization. We actively manage our business continuity plan. We strive to follow all recommendations outlined by the Federal Financial Institutions Examination Council in an effort to provide that we have effectively identified our risks and documented contingency plans for key functions and systems including providing for back-up sites for all critical applications. We perform tests of the adequacy of these contingency plans on at least an annual basis.
The majority of our other systems, including electronic funds transfer and transaction processing, are operated in-house. Online banking services and other public-facing web services are performed using third-party service providers. The scalability of this infrastructure is designed to support our expansion strategy. These critical business applications and processes are included in the business continuity plans referenced above.
Enterprise Risk Management
We place significant emphasis on risk mitigation as an integral component of our organizational culture. We believe that our emphasis on risk management is manifested in our solid asset quality
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statistics and in our historically low charge-offs and losses on deposit-related services due to debit card, ACH or wire fraud. All of the Bank's executive officers serve on the Bank's Management Risk Committee, which is chaired by our Chief Risk Officer. Risk management, with respect to our lending philosophy, focuses on structuring credits to provide for multiple sources of repayment, coupled with strong underwriting and monitoring undertaken by the Bank's experienced officers and credit policy personnel.
Our risk mitigation techniques include weekly Directors Loan Committee meetings where loan pricing, allowance for loan losses methodology and level, and loan concentrations are reviewed and discussed. In addition, the Bank's board of directors reviews portfolio composition reports on a monthly basis. The Bank's Special Assets Committee also meets monthly to discuss criticized assets and set action plans for those borrowers who display deteriorating financial condition, to monitor those relationships and to implement corrective measures on a timely basis to minimize losses. We also perform an annual stress test on our loan portfolio, in which we evaluate the impact on the portfolio of declining economic conditions on the portfolio.
We also focus on risk management in numerous other areas throughout our organization, including asset/liability management, regulatory compliance and strategic and operational risk. We have implemented an extensive asset/liability management process, and utilize a well-known and experienced third party to run our interest rate risk model on a quarterly basis. Our policies provide that we may utilize hedging techniques whenever our models indicate short-term (net interest income) or long-term (economic value of equity) risk-to-interest rate movements, although historically we have not done so.
As of December 31, 2016, management assessed the effectiveness of the Company's internal control over financial reporting based on the criteria for effective internal control over financial reporting established in "Internal Control—Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. This assessment included controls over the preparation of the schedules equivalent to the basic financial statements in accordance with the instructions for the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C) to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act. Based on the assessment, management determined that the Company maintained effective internal control over financial reporting as of December 31, 2016. We also annually engage an experienced third party to review and assess our controls with respect to technology, as well as to perform penetration and vulnerability testing to assist us in managing the risks associated with information security.
Competition
The banking and financial services industry is highly competitive, and we compete with a wide range of financial institutions within our markets, including local, regional and national commercial banks and credit unions. We also compete with mortgage companies, brokerage firms, consumer finance companies, mutual funds, securities firms, insurance companies, third-party payment processors, financial technology (fintech) companies and other financial intermediaries for certain of our products and services. Some of our competitors are not subject to the regulatory restrictions and level of regulatory supervision applicable to us.
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 our competitors are much larger financial institutions that have greater financial resources than we do 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 our industry and markets include office locations and hours, quality of customer service, community reputation, continuity of personnel and services, capacity and willingness to extend credit, and ability to
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offer sophisticated banking products and services. While we seek to remain competitive with respect to fees charged, interest rates and pricing, we believe that our broad and sophisticated suite of financial solutions, our high-quality customer service culture, our positive reputation and our long-standing community relationships will enable us to compete successfully within our markets and enhance our ability to attract and retain customers.
Our Employees
As of June 30, 2017, we employed 472 full-time equivalent persons. We provide extensive training to our employees in an effort to ensure that our customers receive superior customer service. None of our employees are represented by any collective bargaining unit or are parties to a collective bargaining agreement. We consider our relations with our employees to be good.
Our Properties
The Bank currently operates 34 banking locations, all of which are located in Texas. The headquarters of the Bank is located at 5999 Delaware Street, Beaumont, Texas 77706, and the telephone number is (409) 861-7200. The majority of the Bank's and our executive officers, including Robert R. Franklin, Jr., our Chairman, President and Chief Executive Officer, are located in Houston at 9 Greenway Plaza, Suite 110, Houston, Texas 77046, and the telephone number is (713) 210-7600. The Bank currently operates banking locations in the following Texas locations: Baytown, Beaumont (four locations), Boling, Buna, Crosby (two locations), Deweyville, Houston (eight locations), Humble, Jasper, Kirbyville, Lumberton, Nederland, Newton, Orange, Pasadena, Port Arthur, Silsbee, Sugar Land, The Woodlands, Tomball, Vidor, Wharton, and Woodville. We own all of our banking locations, except for five banking locations in Houston, one banking location in Sugar Land, one banking location in The Woodlands, one banking location in Wharton, and two banking locations in Beaumont, at which we either lease the banking location entirely, own the building and have a ground lease, or own the drive-in and lease the branch. We believe that the 10 leases to which we are subject are generally on terms consistent with prevailing market terms. We believe that our facilities are in good condition and are adequate to meet our operating needs for the foreseeable future.
On September 8, 2017, the Bank completed the sale of its Huffman Branch. Pursuant to a purchase and assumption agreement, the Bank sold certain assets associated with the Huffman Branch valued at approximately $1.4 million, other than loans, and the purchaser assumed approximately $15.3 million in deposits at the Huffman Branch. We believe that the sale of the Huffman Branch will reduce our noninterest expense going forward and we do not believe it will impact our liquidity.
On September 14, 2017, we sold the real estate associated with our Deweyville Branch and we leased the facility back for approximately 120 days while we finalize the regulatory process for approval of closing this branch office. We expect to complete the closing of the Deweyville Branch on December 18, 2017. The $4.7 million in deposits and $50,000 of loans at the Deweyville Branch will be transferred to one of our other nearby branch locations. We believe that the closure of the Deweyville Branch will reduce our noninterest expense going forward and we do not believe it will impact our liquidity.
We do not believe that the sale of our Huffman and Deweyville branches represents any strategic shift in our operations.
Legal Proceedings
We are not currently subject to any material legal proceedings. We are from time to time subject to claims and litigation arising in the ordinary course of business. These claims and litigation may include, among other things, allegations of violation of banking and other applicable regulations, competition law, labor laws and consumer protection laws, as well as claims or litigation relating to
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intellectual property, securities, breach of contract and tort. We intend to defend ourselves vigorously against any pending or future claims and litigation.
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 our consolidated results of operations, financial condition or cash flows. However, one or more unfavorable outcomes in any claim or litigation against us 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 our reputation, even if resolved in our favor.
Effects of Hurricane Harvey
In August 2017, Hurricane Harvey, a Category 4 hurricane, caused extensive and costly damage across Southeast Texas. The Houston and Beaumont areas received over 40 inches of rainfall, which resulted in catastrophic flooding and unprecedented damage to residences and businesses. We worked diligently throughout Hurricane Harvey and during its aftermath to ensure the safety of our employees and customers, as well as to continue to provide the financial services on which our customers greatly depend.
The operational impact to our Houston branches and infrastructure was minor. After Hurricane Harvey made landfall in Houston, we operated limited services in Houston from August 28, 2017 until August 31, 2017, which was largely due to the inability of our employees and customers to use the roadways or public transportation. Despite widespread flooding in Houston, none of our Houston branches flooded and all but one of our branches were open and operating at full capacity as of September 1, 2017. The remaining Houston branch reopened on September 6, 2017, after its electricity was restored.
Likewise, the operational impact to our Beaumont branches and infrastructure was minor and none of our Beaumont branches flooded. After Hurricane Harvey shifted course away from Houston and toward Beaumont, we operated limited services in Beaumont from August 29, 2017 until September 4, 2017. In Beaumont, all but one of our branches were open and operating at full capacity as of September 5, 2017. The remaining Beaumont branch reopened on September 11, 2017, after its utilities were restored.
Furthermore, our technology environment, bolstered by our business continuity plan, was fully operational and supported our customers and employees across all of our branches during Hurricane Harvey. Our call center, wire transfer, ATM and treasury services continued to provide telephone and electronic access for customers during the storm. During Hurricane Harvey, our business continuity plan worked as intended and is being reviewed for continued updates and improvements based on the experience.
We have begun to evaluate Hurricane Harvey's impact on our customers and our business, including our properties, assets and loan portfolios. Some of our customers were, and continue to be, adversely impacted by Hurricane Harvey. As part of the recovery process, we have contacted our customers to assist with their needs, as well as waived or refunded (i) late fees for loans with payments due from August 25, 2017 through September 10, 2017, and (ii) overdraft and ATM fees incurred from August 25, 2017 through September 10, 2017.
We have also engaged directly with customers through telephone calls to evaluate the impact of Hurricane Harvey on our consumer, real estate and business loan exposures. As of September 25, 2017, our real estate loan exposures in Houston and Beaumont consist primarily of commercial properties. Based on initial conversations with customers, we have determined that the majority of our significant commercial real estate customers are characterized as low risk (i.e., sustained minimal property
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damage). As of October 20, 2017, we do not anticipate that Hurricane Harvey will result in significant losses and as of October 20, 2017, only one loan relationship in the principal amount of approximately $400,000 appears to have significant uninsured damage and is being monitored by our loan officers and our Senior Credit Officer. Additionally, as of October 20, 2017, we have granted temporary payment deferrals on loans with an aggregate principal amount of approximately $50.1 million, largely to assist customers whose operations were impacted by Hurricane Harvey.
While we do not anticipate that Hurricane Harvey will have significant long-term effects on our business, financial condition or operations, we are unable to predict with certainty the short- and long-term impact that Hurricane Harvey may have on the markets in which we operate, including the impact on our customers and our loan and deposit activities and credit exposures. We will continue to monitor the residual effects of Hurricane Harvey on our business and customers.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Historical Consolidated Financial Data" and our consolidated financial statements and the accompanying notes included elsewhere in this prospectus. This discussion and analysis contains forward-looking statements that are subject to certain risks and uncertainties and are based on certain assumptions that we believe are reasonable but may prove to be inaccurate. Certain risks, uncertainties and other factors, including those set forth under "Cautionary Note Regarding Forward-Looking Statements," "Risk Factors" and elsewhere in this prospectus, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. We assume no obligation to update any of these forward-looking statements. Unless otherwise stated, all information in this prospectus gives effect to a 2-for-1 stock split, whereby each shareholder of our common stock received one additional share of common stock for each share owned as of the record date of September 30, 2017, in the form of a stock dividend that was distributed on October 13, 2017. The effect of the stock split on outstanding shares and per share figures has been retroactively applied to all periods presented.
Overview
We are a bank holding company that operates through our wholly-owned subsidiary, CommunityBank of Texas N.A., in Houston and Beaumont, Texas. We focus on providing commercial banking solutions to small and mid-sized businesses and professionals with operations in our markets. Our market expertise, coupled with a deep understanding of our customers' needs, allows us to deliver tailored financial products and services. We currently operate 18 branches located in the Houston market and our Beaumont market presence includes 16 branches. We have experienced significant organic growth since commencing banking operations in 2007, as well as through multiple mergers of equals, strategic acquisitions and de novo branches. With this growth, we built and expanded our market from Beaumont and East Texas to the growing Houston market. As of June 30, 2017, we had, on a consolidated basis, total assets of $2.9 billion, total loans of $2.2 billion, total deposits of $2.5 billion and total shareholders' equity of $372.0 million.
The following discussion and analysis presents our financial condition and results of operations on a consolidated basis. However, because we conduct all of our material business operations through CommunityBank of Texas, N.A., the discussion and analysis relates to activities primarily conducted by the Bank. As a result of our acquisition of MC Bancshares, Inc., which we completed in February 2015, the results of the acquired operations of MC Bancshares, Inc. were included in our results of operations for a portion of 2015 compared to the full year in 2016.
As a bank holding company that operates through one segment, community banking, we generate most of our revenue from interest on loans and investments, customer service and loan fees, and fees related to the sale of mortgage loans. We incur interest expense on deposits and other borrowed funds, as well as noninterest expense, such as salaries and employee benefits and occupancy expenses. We analyze our ability to maximize income generated from interest-earning assets and control the interest expenses of our liabilities, measured as net interest income, through our net interest margin and net interest spread. Net interest income is 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, which are used to fund those assets. Net interest margin is a ratio calculated as net interest income divided by average interest-earning assets. Net interest spread is the difference between average rates earned on interest-earning assets and average rates paid on interest-bearing liabilities.
Changes in market interest rates and the interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as in the volume and types of interest-earning assets, interest-
83
bearing and noninterest-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 our 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 our target markets and throughout the state of Texas.
Results of Operations
Net Interest Income
Our operating results depend primarily on our 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. Fluctuations in market interest rates impact the yield and rates paid on interest-earning assets and interest-bearing liabilities, respectively. Changes in the amount and type of interest-earning assets and interest-bearing liabilities also impact our net interest income. To evaluate net interest income, we measure and monitor (1) yields on our loans and other interest-earning assets, (2) the costs of our deposits and other funding sources, (3) our net interest spread and (4) our net interest margin. Because noninterest-bearing sources of funds, such as noninterest-bearing deposits and shareholders' equity, also fund interest-earning assets, net interest margin includes the benefit of these noninterest-bearing sources.
Six Months Ended June 30, 2017 vs. Six Months Ended June 30, 2016. Net interest income for the six months ended June 30, 2017 was $52.4 million compared to $50.3 million for six months ended June 30, 2016, an increase of $2.1 million, or 4.17%. For the six months ended June 30, 2017, net interest margin and net interest spread were 3.96% and 3.71%, respectively, compared to 3.92% and 3.68% for the six months ended June 30, 2016. The consistency of net interest margin and net interest spread is primarily attributed to the increase in the average outstanding balances of loans and securities. The increases offset decreases in the average yields in our loan and securities portfolios. Changes in rates paid on interest-bearing deposits for the six months ended June 30, 2017 and June 30, 2016 had a minimal impact on the net interest margin.
Tax equivalent net interest margin, which is defined as net interest income adjusted for tax-free income divided by average interest-earning assets, was 4.05% for the six months ended June 30, 2017, consistent with 4.02% for the six months ended June 30, 2016. Tax equivalent adjustments to net interest margin are the result of increasing income from tax-free securities and loans by an amount equal to the taxes that would have been paid if the income were fully taxable based on a 35% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields. For the six months ended June 30, 2017 and 2016, the adjustments were approximately $1.2 million and $1.2 million, respectively.
The following table presents an analysis of net interest income and net interest spread for the periods indicated, including average outstanding balances for each major category of interest-earning assets and interest-bearing liabilities, the interest earned or paid on such amounts, and the average rate earned or paid on such assets or liabilities, respectively. The table also sets forth the net interest margin on average total interest-earning assets for the same periods. Interest earned on loans that are classified as nonaccrual is not recognized in income; however, the balances are reflected in average outstanding balances for the period. For the six months ended June 30, 2017 and 2016, the amount of
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interest income not recognized on nonaccrual loans was not material. Any nonaccrual loans have been included in the table as loans carrying a zero yield.
| |
For the Six Months Ended June 30, | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2017 | 2016 | |||||||||||||||||
(Dollars in thousands)
|
Average Outstanding Balance |
Interest Earned/ Interest Paid |
Average Yield/ Rate |
Average Outstanding Balance |
Interest Earned/ Interest Paid |
Average Yield/ Rate |
|||||||||||||
Assets |
|||||||||||||||||||
Interest-earnings assets: |
|||||||||||||||||||
Total loans(1) |
$ | 2,190,953 | $ | 52,513 | 4.83 | % | $ | 2,116,681 | $ | 51,304 | 4.89 | % | |||||||
Securities (available for sale and held to maturity) |
219,005 | 2,656 | 2.45 | % | 154,032 | 1,773 | 2.32 | % | |||||||||||
Federal funds sold and other interest-earning assets |
244,053 | 1,186 | 0.98 | % | 299,003 | 810 | 0.55 | % | |||||||||||
Nonmarketable equity securities |
14,688 | 369 | 5.07 | % | 14,684 | 358 | 4.92 | % | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets |
2,668,699 | $ | 56,724 | 4.29 | % | 2,584,400 | $ | 54,245 | 4.23 | % | |||||||||
| | | | | | | | | | | | | | | | | | | | |
Allowance for loan losses |
(25,932 | ) | (26,491 | ) | |||||||||||||||
Noninterest-earnings assets |
275,208 | 265,754 | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total assets |
$ | 2,917,975 | $ | 2,823,663 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders' Equity |
|||||||||||||||||||
Interest-bearing liabilities: |
|||||||||||||||||||
Interest-bearing deposits |
$ | 1,495,867 | $ | 3,695 | 0.50 | % | $ | 1,417,969 | $ | 3,308 | 0.47 | % | |||||||
Repurchase agreements |
2,412 | 3 | 0.25 | % | 2,020 | 3 | 0.30 | % | |||||||||||
Note payable |
26,400 | 515 | 3.93 | % | 30,641 | 545 | 3.59 | % | |||||||||||
Junior subordinated debt |
10,826 | 153 | 2.85 | % | 10,826 | 127 | 2.37 | % | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities |
1,535,505 | $ | 4,366 | 0.57 | % | 1,461,456 | $ | 3,983 | 0.55 | % | |||||||||
| | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing liabilities: |
|||||||||||||||||||
Noninterest-bearing deposits |
998,326 | 1,002,732 | |||||||||||||||||
Other liabilities |
18,157 | 13,370 | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total noninterest-bearing liabilities |
1,016,483 | 1,016,102 | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Shareholders' equity |
365,987 | 346,105 | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total liabilities and shareholders' equity |
$ | 2,917,975 | $ | 2,823,663 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Net interest income |
$ | 52,358 | $ | 50,262 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Net interest spread(2) |
3.71 | % | 3.68 | % | |||||||||||||||
Net interest margin(3) |
3.96 | % | 3.92 | % | |||||||||||||||
Net interest margin—tax equivalent(4) |
4.05 | % | 4.02 | % | |||||||||||||||
- (1)
- Includes
average outstanding balances of loans held for sale of $730,000 and $1.0 million for the six months ended June 30, 2017 and 2016,
respectively.
- (2)
- Net
interest spread is the average yield on interest-earning assets minus the average rate on interest-bearing liabilities.
- (3)
- Net interest margin is equal to net interest income divided by average interest-earning assets.
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- (4)
- In order to make pre-tax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax equivalent adjustment has been computed using a federal income tax rate of 35% for six months ended June 30, 2017.
The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest-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.
| |
For the Six Months Ended June 30, 2017 Compared to 2016 |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
Increase (Decrease) due to |
|
||||||||
| |
Total Increase (Decrease) |
|||||||||
(Dollars in thousands)
|
Volume | Rate | ||||||||
Interest-earning assets: |
||||||||||
Total loans |
$ | 1,800 | $ | (591 | ) | $ | 1,209 | |||
Securities (available for sale and held to maturity) |
748 | 135 | 883 | |||||||
Federal funds sold and other interest-earning assets |
(149 | ) | 525 | 376 | ||||||
Nonmarketable equity securities |
— | 11 | 11 | |||||||
| | | | | | | | | | | |
Total increase (decrease) in interest income |
$ | 2,399 | $ | 80 | $ | 2,479 | ||||
| | | | | | | | | | | |
Interest-bearing liabilities: |
||||||||||
Interest-bearing deposits |
$ | 182 | $ | 205 | $ | 387 | ||||
Repurchase agreements |
— | — | — | |||||||
Note payable |
(75 | ) | 45 | (30 | ) | |||||
Junior subordinated debt |
— | 26 | 26 | |||||||
| | | | | | | | | | | |
Total increase (decrease) in interest expense |
$ | 107 | $ | 276 | $ | 383 | ||||
| | | | | | | | | | | |
Increase (decrease) in net interest income |
$ | 2,292 | $ | (196 | ) | $ | 2,096 | |||
| | | | | | | | | | | |
Year Ended December 31, 2016 vs. Year Ended December 31, 2015. Net interest income for 2016 was $101.5 million compared to $97.9 million for 2015, an increase of $3.7 million, or 3.75%. The increase in net interest income was comprised of a $4.4 million, or 4.19%, increase in interest income offset by a $751,000, or 9.81%, increase in interest expense. The growth in interest income was primarily attributable to a $72.1 million, or 3.48%, increase in average loans outstanding for the year ended December 31, 2016, compared to 2015, partially offset by a three basis point decrease in the yield on total loans. The increase in average loans outstanding was primarily due to organic growth in both of our markets, and specifically loan growth in the Houston market, including from the maturing of our Westchase and The Woodlands branches. The $751,000 increase in interest expense for the year ended December 31, 2016 was primarily related to a $16.4 million, or 1.14%, increase in average interest-bearing deposits over the same period in 2015. The majority of this increase is due to organic growth, primarily in interest-bearing demand deposits, NOW and money market accounts. For the year ended December 31, 2016, net interest margin and net interest spread were 3.87% and 3.63%, respectively, compared to 3.77% and 3.54% for the same period in 2015, which reflects the increases in interest income discussed above relative to the increases in interest expense.
Tax equivalent net interest margin, defined as net interest income adjusted for tax-free income divided by average interest-earning assets, for 2016 was 3.96%, an increase of 11 basis points compared with 3.85% for 2015. This net interest margin increase was primarily due to growth of higher-yielding interest-earning assets, in both our loan portfolio and the state and municipal securities portion of our
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investment portfolio. For the years ended December 31, 2016 and 2015, the adjustments were approximately $2.4 million and $2.1 million, respectively.
The following table presents an analysis of net interest income, net interest spread and net interest margin for the periods indicated in the manner presented for the six months ended June 30, 2017 and 2016 above. For the years ended December 31, 2016 and 2015, the amount of interest income not recognized on nonaccrual loans was not material. Any nonaccrual loans have been included in the table as loans carrying a zero yield.
| |
For the Years Ended December 31, | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2016 | 2015 | |||||||||||||||||
(Dollars in thousands)
|
Average Outstanding Balance |
Interest Earned/ Interest Paid |
Average Yield/ Rate |
Average Outstanding Balance |
Interest Earned/ Interest Paid |
Average Yield/ Rate |
|||||||||||||
Assets |
|||||||||||||||||||
Interest-earnings assets: |
|||||||||||||||||||
Total loans(1) |
$ | 2,140,917 | $ | 103,723 | 4.84 | % | $ | 2,068,827 | $ | 100,786 | 4.87 | % | |||||||
Securities (available for sale and held to maturity) |
169,509 | 3,801 | 2.24 | % | 117,883 | 2,814 | 2.39 | % | |||||||||||
Federal funds sold and other interest-earning assets |
301,018 | 1,732 | 0.58 | % | 402,391 | 1,392 | 0.35 | % | |||||||||||
Nonmarketable equity securities |
14,683 | 695 | 4.73 | % | 9,653 | 533 | 5.52 | % | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets |
2,626,127 | $ | 109,951 | 4.19 | % | 2,598,754 | $ | 105,525 | 4.06 | % | |||||||||
| | | | | | | | | | | | | | | | | | | | |
Allowance for loan losses |
(26,826 | ) | (27,325 | ) | |||||||||||||||
Noninterest-earnings assets |
276,413 | 282,482 | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total assets |
$ | 2,875,714 | $ | 2,853,911 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders' Equity |
|||||||||||||||||||
Interest-bearing liabilities: |
|||||||||||||||||||
Interest-bearing deposits |
$ | 1,458,566 | $ | 7,073 | 0.48 | % | $ | 1,442,194 | $ | 6,501 | 0.45 | % | |||||||
Repurchase agreements |
1,918 | 5 | 0.26 | % | 1,473 | 4 | 0.27 | % | |||||||||||
Note payable |
29,624 | 1,061 | 3.58 | % | 28,113 | 932 | 3.32 | ||||||||||||