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FFIN > SEC Filings for FFIN > Form 10-K on 21-Feb-2014All Recent SEC Filings

Show all filings for FIRST FINANCIAL BANKSHARES INC

Form 10-K for FIRST FINANCIAL BANKSHARES INC


21-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

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

The following discussion and analysis of the major elements of our consolidated balance sheets as of December 31, 2013 and 2012, and consolidated statements of earnings for the years 2011 through 2013 should be read in conjunction with our consolidated financial statements, accompanying notes, and selected financial data presented elsewhere in this Form 10-K.

Critical Accounting Policies

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

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

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

Acquisition of Orange Savings Bank, SSB

On February 9, 2013, we entered into an agreement and plan of merger to acquire Orange Savings Bank, SSB. On May 31, 2013, the transaction was completed. Pursuant to the agreement, we paid $39.20 million in cash and issued 420,000 shares of the Company's common stock in exchange for all of the outstanding shares of Orange Savings Bank, SSB.

At closing, Orange Savings Bank, SSB was merged into First Financial Bank, N.A., Abilene, Texas, a wholly owned subsidiary of the Company. The total purchase price exceeded the estimated fair value of assets acquired by approximately $23.02 million and was recorded by the Company as goodwill.

Consolidation of Bank Charters

Effective December 30, 2012, the Company consolidated its eleven bank charters into one charter. The Company cited regulatory, compliance and technology complexities and the opportunity for cost savings as its reason for making this change. The Company operates the one charter as it previously did with eleven charters, with local management and board decisions to benefit the customers and communities it serves.


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Stock Split

On April 26, 2011, the Company's Board of Directors declared a three-for-two stock split in the form of a 50% stock dividend effective for shareholders of record on May 16, 2011 that was distributed on June 1, 2011. All share and per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares to be issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock on the consolidated financial statements as of and for the year ended December 31, 2011.

Results of Operations

Performance Summary. Net earnings for 2013 were $78.87 million, an increase of $4.64 million, or 6.26%, over net earnings for 2012 of $74.23 million. Net earnings for 2011 were $68.37 million. The increases in net earnings for 2013 over 2012 and 2012 over 2011 were primarily attributable to growth in net interest income and noninterest income.

On a basic net earnings per share basis, net earnings were $2.48 for 2013 as compared to $2.36 for 2012 and $2.17 for 2011. The return on average assets was 1.64% for 2013 as compared to 1.75% for 2012 and 1.78% for 2011. The return on average equity was 13.75% for 2013 as compared to 13.85% for 2012 and 14.44% for 2011.

Net Interest Income. Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits. Tax-equivalent net interest income was $189.00 million in 2013 as compared to $169.32 million in 2012 and $164.85 million in 2011. The increase in 2013 compared to 2012 was largely attributable to an increase in the volume of earning assets. Average earning assets were $4.48 billion in 2013, as compared to $3.95 billion in 2012 and $3.57 billion in 2011. Average earning assets increased $525.62 million in 2013 with increases in all categories of earning assets, except for short-term investments and taxable investment securities. The yield on earning assets decreased ten basis points in 2013, whereas the rate paid on interest-bearing liabilities decreased six basis points. The increase in 2012 compared to 2011 also resulted from an increase in the volume of earnings assets and from the decrease in the rates paid on interest-bearing liabilities.

Table 1 allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and to rate.

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



                                                 2013 Compared to 2012                          2012 Compared to 2011
                                         Change Attributable to          Total          Change Attributable to          Total
                                         Volume            Rate          Change         Volume            Rate          Change
Short-term investments                 $      (327 )     $      81      $   (246 )    $      (369 )     $     (97 )    $   (466 )
Taxable investment securities               (2,525 )        (3,288 )      (5,813 )          1,451          (7,854 )      (6,403 )
Tax-exempt investment securities (1)         7,613          (2,519 )       5,094           11,259          (6,185 )       5,074
Loans (1) (2)                               28,236          (8,612 )      19,624           11,342          (7,985 )       3,357

Interest income                             32,997         (14,338 )      18,659           23,683         (22,121 )       1,562

Interest-bearing deposits                      559          (1,727 )      (1,168 )            323          (3,268 )      (2,945 )
Short-term borrowings                          129              15           144               65             (31 )          34

Interest expense                               688          (1,712 )      (1,024 )            388          (3,299 )      (2,911 )

Net interest income                    $    32,309       $ (12,626 )    $ 19,683      $    23,295       $ (18,822 )    $  4,473

(1) Computed on tax-equivalent basis assuming marginal tax rate of 35%.

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


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The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated in Table 2 for the years 2011 through 2013. The net interest margin in 2013 was 4.22%, a decrease of six basis points from 2012 which also decreased an additional 34 basis points from 2011. The decrease in our net interest margin in 2013 was largely the result of the extended period of historically low levels of short-term interest rates. The Federal funds rate remained at zero to 0.25% during 2011 to 2013. We have been able to somewhat mitigate the impact of low short-term interest rates by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and reducing rates paid on interest bearing liabilities. We expect interest rates to remain at the current low levels until 2015 as announced by the Federal Reserve Board which will continue to place pressure on our interest margin.

The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated in Table 2.

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

                                                              2013                                        2012                                        2011
                                               Average         Income/      Yield/         Average         Income/      Yield/         Average         Income/      Yield/
                                               Balance         Expense       Rate          Balance         Expense       Rate          Balance         Expense       Rate
Assets
Short-term investments (1)                   $    81,822      $     509        0.62 %    $   134,588      $     754        0.61 %    $   181,068      $   1,221        0.69 %
Taxable investment securities (2)              1,052,453         25,505        2.42        1,144,763         31,318        2.74        1,102,356         37,721        3.42
Tax-exempt investment securities (2)(3)          911,472         44,143        4.84          762,754         39,049        5.12          572,895         33,975        5.93
Loans (3)(4)                                   2,431,872        122,935        5.06        1,909,890        103,312        5.41        1,715,266         99,955        5.83

Total earning assets                           4,477,619        193,092        4.31        3,951,995        174,433        4.41        3,571,585        172,872        4.84
Cash and due from banks                          129,222                                     120,477                                     113,423
Bank premises and equipment, net                  91,341                                      80,315                                      72,381
Other assets                                      49,084                                      47,891                                      51,870
Goodwill and other intangible assets, net         86,809                                      72,041                                      72,312
Allowance for loan losses                        (34,815 )                                   (34,802 )                                   (33,244 )

Total assets                                 $ 4,799,260                                 $ 4,237,917                                 $ 3,848,327

Liabilities and Shareholders' Equity
Interest-bearing deposits                    $ 2,513,674      $   3,709        0.15 %    $ 2,255,239      $   4,877        0.22 %    $ 2,165,750      $   7,822        0.36 %
Short-term borrowings                            400,545            379        0.09          258,863            235        0.09          196,230            202        0.10

Total interest-bearing liabilities             2,914,219          4,088        0.14        2,514,102          5,112        0.20        2,361,980          8,024        0.34
Noninterest-bearing deposits                   1,266,135                                   1,132,862                                     973,588
Other liabilities                                 45,521                                      55,021                                      39,354

Total liabilities                              4,225,875                                   3,701,985                                   3,374,922
Shareholders' equity                             573,385                                     535,932                                     473,405

Total liabilities and shareholders' equity   $ 4,799,260                                 $ 4,237,917                                 $ 3,848,327

Net interest income                                           $ 189,004                                   $ 169,321                                   $ 164,848

Rate Analysis:
Interest income/earning assets                                                 4.31 %                                      4.41 %                                      4.84 %
Interest expense/earning assets                                                0.09                                        0.13                                        0.22

Net yield on earning assets                                                    4.22 %                                      4.28 %                                      4.62 %

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


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

(3) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.

(4) Nonaccrual loans are included in loans.

Noninterest Income. Noninterest income for 2013 was $62.05 million, an increase of $4.84 million, or 8.47%, as compared to 2012. Increases in certain categories of noninterest income included (1) ATM, interchange and credit card fees of $1.56 million principally as a result of increased use of debit cards, (2) trust fees of $1.85 million, (3) real estate mortgage operations of $1.26 million and
(4) service charges on deposit accounts of $853 thousand. Under the Dodd-Frank Act, the Federal Reserve Board was authorized to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers. While the changes relate only to banks with assets greater than $10 billion, concern exists that the regulation will also impact our Company in the future. The increase in trust fees was primarily due to the growth in assets under management over the prior year as well as higher fees generated from oil and gas management. The fair value of our trust assets, which are not reflected in our consolidated balance sheets, totaled $3.36 billion at December 31, 2013 compared to $2.85 billion at December 31, 2012. The increases in income from real estate secondary market mortgage operations reflected a higher level of new home and home sale financing from additional resources devoted to expanding the Company's mortgage loan operations although we experienced a decrease in such fees in the fourth quarter of 2013. The increase in service charges on deposit accounts was primarily due to our Orange acquisition and to an increase in the number of deposit accounts offset by changes in overdraft regulations. Beginning in the third quarter of 2010, a new rule issued by the Federal Reserve Board prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machine and debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. Consumers must be provided a notice that explains the financial institution's overdraft services, including the fees associated with the service, and the consumer's choices. We continue to monitor the impact of these new regulations and other related developments on our service charge revenue.

These increases in noninterest income were offset by a decrease of $2.63 million in net gain on sale of available-for-sale securities when compared to amounts recorded in 2012.

Noninterest income for 2012 was $57.21 million, an increase of $5.77 million, or 11.22%, as compared to 2011. Increases in certain categories of noninterest income included (1) ATM, interchange and credit card fees of $1.60 million principally as a result of increased use of debit cards, (2) trust fees of $1.79 million, (3) real estate mortgage operations of $1.15 million and (4) the net gain on sale of available-for-sale securities of $2.28 million. The increase in trust fees was primarily due to the growth in assets under management over the prior year as well as higher fees generated from oil and gas management. The fair value of our trust assets, which are not reflected in our consolidated balance sheets, totaled $2.85 billion at December 31, 2012 compared to $2.43 billion at December 31, 2011. The increases in income from real estate mortgage operations reflected a higher level of refinancing activity due to the favorable interest rate environment and additional resources devoted to expanding the Company's mortgage loan operations.

These increases in noninterest income were offset by a $996 thousand decrease in service charges on deposit accounts and a decrease of $690 thousand in net gains on sale of assets when compared to amounts recorded in 2011. The decrease in service charges on deposit accounts was primarily due to a reduction in customer use of overdraft services and changes in overdraft regulations. The reduction in gains on the sales of assets resulted from a $1.00 million gain recorded in 2011 relating to the sale of the former banking facilities in Cleburne and Southlake.


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Table 3-Noninterest Income (in thousands):



                                                     Increase                          Increase
                                      2013          (Decrease)          2012          (Decrease)          2011
Trust fees                          $ 16,317       $      1,853       $ 14,464       $      1,793       $ 12,671
Service charges on deposit
accounts                              17,546                853         16,693               (996 )       17,689
ATM, interchange and credit card
fees                                  16,750              1,563         15,187              1,600         13,587
Real estate mortgage operations        6,349              1,255          5,094              1,151          3,943
Net gain on sale of
available-for-sale securities            147             (2,625 )        2,772              2,280            492
Net gain (loss) on sale of
foreclosed assets                       (152 )              198           (350 )              965         (1,315 )
Other:
Check printing fees                      229                 24            205                 (4 )          209
Safe deposit rental fees                 503                 50            453                 -             453
Credit life and debt protection
fees                                     226                 (3 )          229                (17 )          246
Brokerage commissions                    697                519            178                (48 )          226
Interest on loan recoveries              468                151            317               (281 )          598
Gain on sales of assets, net             183                (24 )          207               (690 )          897
Miscellaneous income                   2,789              1,029          1,760                 18          1,742

Total other                            5,095              1,746          3,349             (1,022 )        4,371

Total Noninterest Income            $ 62,052       $      4,843       $ 57,209       $      5,771       $ 51,438

Noninterest Expense. Total noninterest expense for 2013 was $126.01 million, an increase of $16.96 million, or 15.56%, as compared to 2012. Noninterest expense for 2012 amounted to $109.05 million, an increase of $4.43 million, or 4.23%, as compared to 2011. An important measure in determining whether a banking company effectively manages noninterest expenses is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for 2013 was 50.19% compared to 48.14% for 2012, and 48.37% for 2011. The primary reason for the increase in 2013 was costs related to acquisitions and conversion for our Orange acquisition.

Salaries and employee benefits for 2013 totaled $66.53 million, an increase of $8.26 million, or 14.18%, as compared to 2012. The principal causes of this increase were (1) additional salaries from our Orange acquisition,
(2) additional employees to staff new branches, (3) an increase in profit sharing expense, and (4) an increase in medical claims.

All other categories of noninterest expense for 2013 totaled $59.48 million, an increase of $8.70 million, or 17.14%, as compared to 2012. The increase in noninterest expense was largely the result of increases in other miscellaneous expense of $3.55 million, net occupancy expense of $1.02 million, professional and service fees of $1.10 million and equipment expense of $883 thousand. The increases in other miscellaneous expense and professional and service fees were largely attributable to IT termination and conversion costs associated with our Orange acquisition. The increases in net occupancy and equipment costs were likewise primarily from increased costs from our Orange acquisition.

Salaries and employee benefits for 2012 totaled $58.27 million, an increase of $2.01 million, or 3.58%, as compared to 2011. The principal causes of this increase were additional employees to staff new branches, increases in salaries and related payroll taxes and pension expense. The increase in salaries and related payroll taxes were largely the result of annual merit increases.

All other categories of noninterest expense for 2012 totaled $50.78 million, an increase of $2.41 million, or 4.99%, as compared to 2011. The increase in noninterest expense was largely the result of increases in ATM, interchange and credit card expenses of $530 thousand, net occupancy expense of $214 thousand, equipment


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expense of $990 thousand, software amortization and expense of $808 thousand and legal expense of $164 thousand. The increase in ATM, interchange and credit card expenses was largely the result of increased use of debit cards discussed above. The increases in net occupancy and equipment expenses were the result of the Company's investment in several new branches. The software expense and legal expense increase was due primarily to costs related to combining the databases of our eleven charters into one charter. Partially offsetting these increases were a reduction in FDIC insurance premiums of $426 thousand, other real estate expense reduction of $532 thousand and reductions in several other categories of noninterest expense. The decrease in FDIC insurance premiums resulted from changes in the insurance assessment base and rates under the Dodd-Frank Act. The decrease in other real estate expense is a result of less foreclosure activities and other real estate held.

Table 4-Noninterest Expense (in thousands):



                                                    Increase                        Increase
                                      2013         (Decrease)         2012         (Decrease)         2011
Salaries                            $  49,866     $      5,374      $  44,492     $      1,825      $  42,667
Medical                                 4,826            1,396          3,430             (217 )        3,647
Profit sharing                          5,686              975          4,711               23          4,688
Pension                                   556              (76 )          632              278            354
401(k) match expense                    1,560              177          1,383               78          1,305
Payroll taxes                           3,624              337          3,287              119          3,168
Stock option expense                      411               77            334              (93 )          427

Total salaries and employee
benefits                               66,529            8,260         58,269            2,013         56,256

Net occupancy expense                   8,095            1,019          7,076              214          6,862
Equipment expense                       9,673              883          8,790              990          7,800
FDIC insurance premiums                 2,418              198          2,220             (426 )        2,646
ATM, interchange and credit card
expenses                                5,660              212          5,448              530          4,918
Professional and service fees           4,143            1,099          3,044             (188 )        3,232
Printing, stationery and supplies       2,066               96          1,970              139          1,831
Amortization of intangible assets         197               48            149             (253 )          402

Other:
Data processing fees                      249               (7 )          256             (241 )          497
Postage                                 1,534              131          1,403               22          1,381
Advertising                             2,774              551          2,223              121          2,102
Correspondent bank service
charges                                   915               59            856               52            804
Telephone                               2,067              513          1,554               69          1,485
Public relations and business
development                             2,059              305          1,754               39          1,715
Directors' fees                           867               98            769               13            756
Audit and accounting fees               1,719              326          1,393               47          1,346
Legal fees                                725             (231 )          956              164            792
Regulatory exam fees                      825             (246 )        1,071              122            949
Travel                                    993              218            775               80            695
Courier expense                           732              (34 )          766              108            658
Operational and other losses            1,353              237          1,116               52          1,064
Other real estate                         525               12            513             (532 )        1,045
Software amortization and expense       1,832             (336 )        2,168              808          1,360
Other miscellaneous expense             8,062            3,552          4,510              482          4,028

Total other                            27,231            5,148         22,083            1,406         20,677

Total Noninterest Expense           $ 126,012     $     16,963      $ 109,049     $      4,425      $ 104,624


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Income Taxes. Income tax expense was $25.70 million for 2013 as compared to $25.14 million for 2012 and $23.82 million for 2011. Our effective tax rates on . . .

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