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FFIN > SEC Filings for FFIN > Form 10-K on 17-Feb-2017All Recent SEC Filings

Show all filings for FIRST FINANCIAL BANKSHARES INC

Form 10-K for FIRST FINANCIAL BANKSHARES INC


17-Feb-2017

Annual Report


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

The following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements as a result of certain factors, including but not limited to those listed in "Item 1A - Risk Factors" and in the "Cautionary Statement Regarding Forward-Looking Statements" notice on page 1.

Introduction

As a financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans and investments are deposits held by our bank subsidiary, First Financial Bank, National Association, Abilene, Texas. Our largest expenses are salaries and related employee benefits. We 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, 2016 and 2015, and consolidated statements of earnings for the years 2014 through 2016 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 ("GAAP") and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.

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

We deem our most critical accounting policies to be (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period. A discussion of (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities is included in Note 1 to our Consolidated Financial Statements beginning on page F-7.

Acquisitions and Asset Purchase

On April 1, 2015, we entered into an agreement and plan of reorganization to acquire FBC Bancshares, Inc. and its wholly owned bank subsidiary, First Bank, N.A., Conroe, Texas. On July 31, 2015, the transaction was completed, which we refer to herein as the "Conroe acquisition." Pursuant to the agreement, we issued 1,755,374 shares of the Company's common stock in exchange for all of the outstanding shares of FBC Bancshares, Inc. At closing, FBC Bancshares, Inc. was merged into the Company and First Bank, N.A., Conroe, Texas, was merged into First Financial Bank, National Association, Abilene, Texas, a wholly owned subsidiary of the Company. The total purchase price exceeded the estimated fair value of assets acquired by approximately $43.92 million and the Company recorded such excess as goodwill.


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On April 8, 2015, the Company announced that it had entered into an asset purchase agreement with 4Trust Mortgage, Inc. for a cash purchase price of $1.90 million. The asset purchase was finalized on June 1, 2015, which we refer to herein as the "4Trust asset purchase." The total asset purchase price exceeded the estimated fair value of assets purchased by approximately $1.75 million and the Company recorded such excess as goodwill.

Stock Split

On April 22, 2014 the Company's Board of Directors declared a two-for-one stock split in the form of a 100% stock dividend effective for shareholders of record on May 15, 2014 that was distributed on June 2, 2014. 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, 2014.

Results of Operations

Performance Summary. Net earnings for 2016 were $104.77 million, an increase of $4.39 million, or 4.38%, over net earnings for 2015 of $100.38 million. Net earnings for 2014 were $89.56 million. The increases in net earnings for 2016 over 2015 and 2015 over 2014 were primarily attributable to growth in net interest income and noninterest income.

On a basic net earnings per share basis, net earnings were $1.59 for 2016 as compared to $1.55 for 2015 and $1.40 for 2014. The return on average assets was 1.59% for 2016 as compared to 1.61% for 2015 and 1.65% for 2014. The return on average equity was 12.36% for 2016 as compared to 13.60% for 2015 and 14.00% for 2014.

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 $251.78 million in 2016, as compared to $240.48 million in 2015 and $213.49 million in 2014. The increases in 2016 compared to 2015 and in 2015 compared to 2014 were largely attributable to increases in the volume of earning assets, primarily from our Conroe acquisition. Average earning assets were $6.17 billion in 2016, as compared to $5.84 billion in 2015 and $5.08 billion in 2014. Average earning assets increased $333.39 million in 2016, when compared to 2015, due primarily from increases in loans and tax exempt securities. Average earning assets increased $757.55 million in 2015, when compared to 2014, with increases in all categories of earning assets, except for short-term investments. Average interest bearing liabilities were $4.02 billion in 2016, as compared to $3.80 billion in 2015 and $3.30 billion in 2014. The yield on earning assets decreased two basis points in 2016, whereas the rate paid on interest-bearing liabilities increased three basis point when compared to 2015. The yield on earning assets decreased nine basis points in 2015, whereas the rate paid on interest-bearing liabilities decreased two basis points when compared to 2014.

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


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



                                                   2016 Compared to 2015                          2015 Compared to 2014
                                           Change Attributable to          Total          Change Attributable to          Total
                                           Volume             Rate         Change         Volume             Rate         Change

Short-term investments                   $        23        $    111      $    134      $       (88 )      $    (74 )    $   (162 )
Taxable investment securities                 (1,218 )          (829 )      (2,047 )          4,777          (3,506 )       1,271
Tax-exempt investment securities (1)           6,548          (1,687 )       4,861           13,241          (2,491 )      10,750
Loans (1) (2)                                 12,037          (2,320 )       9,717           15,110             (73 )      15,037

Interest income                               17,390          (4,725 )      12,665           33,040          (6,144 )      26,896

Interest-bearing deposits                        219             643           862              490            (731 )        (241 )
Short-term borrowings                             24             477           501               95              53           148

Interest expense                                 243           1,120         1,363              585            (678 )         (93 )

Net interest income                      $    17,147        $ (5,845 )    $ 11,302      $    32,455        $ (5,466 )    $ 26,989

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

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

The net interest margin in 2016 was 4.08%, a decrease of four basis points from 2015 which also decreased an additional 8 basis points from 2014. The continued decrease in our net interest margin in 2016 was largely the result of the extended period of historically low levels of short-term interest rates. 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. Although the Federal Reserve increased rates 25 basis points in both December 2016 and December 2015 and continues to issue forward guidance plans to increase rates further in 2017 and future years, we expect interest rates to remain at lower levels, which will continue the downward pressure on our net 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 for the years 2014 through 2016.

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

                                                              2016                                        2015                                        2014
                                               Average         Income/      Yield/         Average         Income/      Yield/         Average         Income/      Yield/
                                               Balance         Expense       Rate          Balance         Expense       Rate          Balance         Expense       Rate
Assets
Short-term investments (1)                   $    63,882      $     342        0.54 %    $    57,500      $     208        0.36 %    $    75,093      $     370        0.49 %
Taxable investment securities (2)              1,314,820         27,626        2.10        1,371,110         29,673        2.16        1,173,725         28,402        2.42
Tax-exempt investment securities (2)(3)        1,459,121         66,268        4.54        1,318,531         61,407        4.66        1,045,304         50,657        4.85
Loans (3)(4)                                   3,333,241        162,994        4.89        3,090,538        153,277        4.96        2,786,011        138,240        4.96

Total earning assets                           6,171,064      $ 257,230        4.17 %      5,837,679      $ 244,565        4.19 %      5,080,133      $ 217,669        4.28 %
Cash and due from banks                          152,648                                     148,369                                     144,029
Bank premises and equipment, net                 120,538                                     109,725                                      98,828
Other assets                                      55,694                                      49,647                                      43,749
Goodwill and other intangible assets, net        143,986                                     117,491                                      97,443
Allowance for loan losses                        (44,811 )                                   (39,107 )                                   (35,599 )

Total assets                                 $ 6,599,119                                 $ 6,223,804                                 $ 5,428,583

Liabilities and Shareholders' Equity
Interest-bearing deposits                    $ 3,469,005      $   4,504        0.13 %    $ 3,272,150      $   3,642        0.11 %    $ 2,905,734      $   3,883        0.13 %
Short-term borrowings                            552,041            947        0.17          524,365            446        0.08          397,738            298        0.07

Total interest-bearing liabilities             4,021,046      $   5,451        0.14 %      3,796,515      $   4,088        0.11 %      3,303,472      $   4,181        0.13 %
Noninterest-bearing deposits                   1,666,598                                   1,634,669                                   1,441,125
Other liabilities                                 63,609                                      54,331                                      44,242

Total liabilities                              5,751,253                                   5,485,515                                   4,788,839
Shareholders' equity                             847,866                                     738,289                                     639,744

Total liabilities and shareholders' equity   $ 6,599,119                                 $ 6,223,804                                 $ 5,428,583

Net interest income                                           $ 251,779                                   $ 240,477                                   $ 213,488

Rate Analysis:
Interest income/earning assets                                                 4.17 %                                      4.19 %                                      4.28 %
Interest expense/earning assets                                                0.09                                        0.07                                        0.08

Net yield on earning assets                                                    4.08 %                                      4.12 %                                      4.20 %


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

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

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

(4) Nonaccrual loans are included in loans.

Noninterest Income. Noninterest income for 2016 was $85.13 million, an increase of $11.70 million, or 15.93%, as compared to 2015. Increases in certain categories of noninterest income included (1) real estate mortgage fees of $5.68 million, (2) ATM, interchange and credit card fees of $2.05 million
(3) service charges on deposit accounts of $1.22 million and (4) trust fees of $384 thousand when compared to 2015. The increase in real estate mortgage fees primarily resulted from a stronger mortgage market and the 4Trust asset purchase on June 1, 2015. The increases in ATM, interchange and credit card fees and service charges on deposit accounts are primarily a result of increases in the number of net new accounts and debit cards boosted by the Conroe acquisition on July 31, 2015. The increase in trust fees resulted from an increase in assets under management over the prior year offsetting the effect of the decline in oil and gas prices that reduced related trust fees by $296 thousand in 2016 compared to 2015. The fair value of our trust assets managed, which are not reflected in our consolidated balance sheets, totaled $4.37 billion at December 31, 2016 as compared to $3.87 billion at December 31, 2015.

Noninterest income for 2015 was $73.43 million, an increase of $6.81 million, or 10.22%, as compared to 2014. Increases in certain categories of noninterest income included (1) real estate mortgage fees of $3.90 million, (2) ATM, interchange and credit card fees of $2.43 million and (3) trust fees of $486 thousand when compared to 2014. The increase in real estate mortgage fees primarily resulted from a stronger mortgage market and the 4Trust asset purchase on June 1, 2015. The increases in ATM, interchange and credit card fees are primarily a result of increases in the number of net new accounts and debit cards boosted by the Conroe acquisition on July 31, 2015. The increase in trust fees resulted from an increase in assets under management over the prior year offsetting the effect of the decline in oil and gas prices that reduced related trust fees by $1.15 million in 2015 compared to 2014. The fair value of our trust assets managed, which are not reflected in our consolidated balance sheets, totaled $3.87 billion at December 31, 2015 as compared to $3.76 at December 31, 2014.

Offsetting the increases in 2015 was a loss on sale of assets of $820 thousand and a decline in net gains on sale of foreclosed assets of $366 thousand when compared to 2014.

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


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Table 3 - Noninterest Income (in thousands):



                                                        Increase                        Increase
                                           2016        (Decrease)         2015         (Decrease)         2014

Trust fees                               $ 19,636     $        384      $ 19,252      $        486      $ 18,766
Service charges on deposit accounts        18,386            1,215        17,171               261        16,910
ATM, interchange and credit card fees      23,910            2,050        21,860             2,433        19,427
Real estate mortgage operations            16,086            5,677        10,409             3,898         6,511
Net gain on sale of available-for-sale
securities                                  1,270              838           432               436            (4 )
Net gain (loss) on sale of foreclosed
assets                                        456              (82 )         538              (366 )         904
Net gain (loss) on sale of assets             168              988          (820 )            (830 )          10
Interest on loan recoveries                 2,112            1,062         1,050               449           601
Other:
Check printing fees                           190              (40 )         230                 7           223
Safe deposit rental fees                      531                7           524                (9 )         533
Credit life and debt protection fees          619              (44 )         663               449           214
Brokerage commissions                         573             (190 )         763              (108 )         871
Miscellaneous income                        1,195             (165 )       1,360              (298 )       1,658

Total other                                 3,108             (432 )       3,540                41         3,499

Total Noninterest Income                 $ 85,132     $     11,700      $ 73,432      $      6,808      $ 66,624

Noninterest Expense. Total noninterest expense for 2016 was $165.83 million, an increase of $16.37 million, or 10.95%, as compared to 2015. Noninterest expense for 2015 amounted to $149.46 million, an increase of $11.54 million, or 8.37%, as compared to 2014. An important measure in determining whether a financial institution 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 2016 was 49.22%, as compared to 47.61% for 2015 and 49.24% for 2014.

Salaries and employee benefits for 2016 totaled $90.74 million, an increase of $9.74 million, or 12.02%, as compared to 2015. The increase was primarily driven by the addition of employees from the Conroe acquisition and the 4Trust asset purchase, annual merit pay increases and increases in healthcare claims. Offsetting these increases was a reduction in profit sharing and officer bonus expenses in 2016 when compared to 2015, which was caused by less net income growth in 2016 when compared to the prior year.

All other categories of noninterest expense for 2016 totaled $75.09 million, an increase of $6.63 million, or 9.68%, as compared to 2015. The increase in noninterest expense was largely attributable to increases in equipment expense of $1.26 million, largely resulting from the Company's acquisition of Conroe. Telephone expenses increased $1.05 million due to costs to improve our technology infrastructure and professional and service fees increased $2.05 million due primarily to outsourcing expenses for certain technology providers, which offset salary costs. Offsetting these increases in 2016 were a decrease of $473 thousand in FDIC insurance due to the lower rate charged by the FDIC beginning in the third quarter of 2016.

Salaries and employee benefits for 2015 totaled $81.00 million, an increase of $10.54 million, or 14.96%, as compared to 2014. The increase was largely the result of the addition of employees in compliance-related areas, the addition of employees from the 4Trust asset purchase and Conroe acquisition, increases in healthcare claims and annual merit pay increases.

All other categories of noninterest expense for 2015 totaled $68.47 million, an increase of $996 thousand, or 1.48%, as compared to 2014. The increase in noninterest expense was largely attributable to increases in equipment expense of $1.48 million, net occupancy expense of $1.21 million, legal expense of $1.13 million and software amortization and expense of $696 thousand, largely resulting from the Company's 4Trust asset purchase and Conroe acquisition in 2015. Offsetting these increases in 2015 were declines in pension expense and the litigation settlement and expenses related to storm damage that were recognized in 2014.


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Table 4 - Noninterest Expense (in thousands):



                                                        Increase                        Increase
                                          2016         (Decrease)         2015         (Decrease)         2014

Salaries                                $  69,997     $      7,294      $  62,703     $      9,220      $  53,483
Medical                                     8,759            3,066          5,693              508          5,185
Profit sharing                              3,221           (2,234 )        5,455              131          5,324
Pension                                       359              342             17             (155 )          172
401(k) match expense                        2,331              288          2,043              344          1,699
Payroll taxes                               4,809              427          4,382              498          3,884
Stock option expense                          882              238            644              (65 )          709
Restricted stock expense                      381              319             62               62             -

Total salaries and employee benefits       90,739            9,740         80,999           10,543         70,456

Loss from partial settlement of
pension plan                                  267              267             -            (2,909 )        2,909
Net occupancy expense                      10,420              106         10,314            1,214          9,100
Equipment expense                          13,479            1,257         12,222            1,482         10,740
FDIC insurance premiums                     2,680             (473 )        3,153              428          2,725
ATM, interchange and credit card
expenses                                    7,231              847          6,384             (486 )        6,870
Professional and service fees               6,877            2,046          4,831              536          4,295
Printing, stationery and supplies           2,093             (185 )        2,278             (359 )        2,637
Amortization of intangible assets             738              177            561              286            275

Other:
Data processing fees                          463               63            400               91            309
Postage                                     1,664              (41 )        1,705               35          1,670
Advertising                                 3,536              353          3,183             (407 )        3,590
Correspondent bank service charges            964               39            925               38            887
Telephone                                   3,253            1,053          2,200               62          2,138
Public relations and business
development                                 2,748               48          2,700              343          2,357
Directors' fees                             1,320              218          1,102              237            865
Audit and accounting fees                   1,712               55          1,657               96          1,561
Legal fees                                  2,096               95          2,001            1,134            867
Regulatory exam fees                        1,131               43          1,088              161            927
Travel                                      1,242               28          1,214              256            958
Courier expense                               848               39            809               25            784
Operational and other losses                2,170              281          1,889           (1,792 )        3,681
Other real estate                             182               58            124             (346 )          470
Software amortization and expense           2,006             (116 )        2,122              696          1,426
Other miscellaneous expense                 5,971              368          5,603              175          5,428

Total other                                31,306            2,584         28,722              804         27,918

Total Noninterest Expense               $ 165,830     $     16,366      $ 149,464     $     11,539      $ 137,925

Income Taxes. Income tax expense was $31.15 million for 2016, as compared to $31.44 million for 2015 and $29.03 million for 2014. Our effective tax rates on pretax income were 22.92%, 23.85% and 24.48%, respectively, for the years 2016, 2015 and 2014. The effective tax rates differ from the statutory federal tax rate of 35.0% largely due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan and income tax deductions from the partial . . .

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