LOANS AND ALLOWANCE FOR LOAN LOSSES

12 Months Ended

Dec. 31, 2022

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


	December 31, 2022		December 31, 2021
Real estate loans:
Construction	$	559,681	$	447,860
1-4 family residential	663,519		651,140
Commercial	1,987,707		1,598,172
Commercial loans	412,064		418,998
Municipal loans	450,067		443,078
Loans to individuals	74,653		85,914
Total loans	4,147,691		3,645,162
Less: Allowance for loan losses	36,515		35,273
Net loans	$	4,111,176	$	3,609,889

Loans to Affiliated Parties

In the normal course of business, we make loans to certain of our executive officers and directors and their related interests. As of December 31, 2022 and 2021, these loans totaled $14.2 million and $28.3 million, respectively. These loans represented 1.9% and 3.1% of shareholders’ equity as of December 31, 2022 and 2021, respectively.

Paycheck Protection Program Loans

In April 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. Loans covered by the PPP may be eligible for loan forgiveness for certain costs incurred related to payroll, group health care benefit costs and qualifying mortgage, rent and utility payments. The remaining loan balance after forgiveness of any amount is still fully guaranteed by the SBA. On December 27, 2020, the Economic Aid Act was signed into law. This second coronavirus relief package granted additional funds for a new round of PPP loans. Additionally, it expanded the eligibility for loans and allowed certain businesses to request a second loan. In return for processing and booking a PPP loan, the SBA paid lenders a processing fee tiered by the size of the loan. These loans are included in commercial loans with an amortized cost basis at December 31, 2022 and 2021 of $113,000 and $31.0 million, respectively.

Construction Real Estate Loans

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

1-4 Family Residential Real Estate Loans

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

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

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

Commercial Real Estate Loans

Commercial real estate loans as of December 31, 2022 consisted of $1.60 billion of owner and non-owner occupied real estate, $363.3 million of loans secured by multi-family properties and $26.3 million of loans secured by farmland. Commercial real estate loans primarily include loans collateralized by retail, commercial office buildings, multi-family residential buildings, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches. In determining whether to originate commercial real estate loans, we generally consider such factors as the financial condition of the borrower and the debt service coverage of the property. Commercial real estate loans are made at both fixed and adjustable interest rates for terms generally up to 20 years.

Commercial Loans

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

Municipal Loans

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

Loans to Individuals

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

Credit Quality Indicators

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

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

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

▪A lack of, or abnormally extended payment program;

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

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

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

•Special Mention (Rating 6) – A Special Mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for

the loan or in our credit position at some future date. Special Mention loans are not adversely classified and do not expose us to sufficient risk to warrant adverse classification.

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

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

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


December 31, 2022	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans Amortized Cost Basis		Total
	2022		2021		2020		2019		2018		Prior
Construction real estate:
Pass	$	169,652	$	184,501	$	34,537	$	7,091	$	1,844	$	6,434	$	152,530	$	556,589
Pass watch	299		—		—		—		—		—		—		299
Special mention	1,858		290		—		—		—		—		—		2,148
Substandard	—		—		—		10		42		194		—		246
Doubtful	—		44		—		355		—		—		—		399
Total construction real estate	$	171,809	$	184,835	$	34,537	$	7,456	$	1,886	$	6,628	$	152,530	$	559,681

1-4 family residential real estate:
Pass	$	82,847	$	144,424	$	128,666	$	70,142	$	36,710	$	194,490	$	2,160	$	659,439
Pass watch	—		—		—		—		—		—		—		—
Special mention	—		—		79		—		1,397		—		—		1,476
Substandard	3		—		217		54		32		1,942		43		2,291
Doubtful	—		—		—		—		173		140		—		313
Total 1-4 family residential real estate	$	82,850	$	144,424	$	128,962	$	70,196	$	38,312	$	196,572	$	2,203	$	663,519

Commercial real estate:
Pass	$	798,653	$	546,938	$	168,607	$	136,440	$	55,480	$	233,509	$	12,315	$	1,951,942
Pass watch	—		9,219		—		—		—		—		—		9,219
Special mention	—		—		1,832		330		115		1,849		—		4,126
Substandard	—		—		281		14,603		260		6,992		—		22,136
Doubtful	—		—		—		76		—		208		—		284
Total commercial real estate	$	798,653	$	556,157	$	170,720	$	151,449	$	55,855	$	242,558	$	12,315	$	1,987,707

Commercial loans:
Pass	$	113,678	$	68,509	$	17,852	$	8,249	$	4,820	$	3,313	$	178,951	$	395,372
Pass watch	208		13		56		—		—		—		—		277
Special mention	—		5,109		31		—		288		—		9,986		15,414
Substandard	220		116		70		110		12		9		—		537
Doubtful	68		100		—		86		210		—		—		464
Total commercial loans	$	114,174	$	73,847	$	18,009	$	8,445	$	5,330	$	3,322	$	188,937	$	412,064

Municipal loans:
Pass	$	65,258	$	74,617	$	57,147	$	47,636	$	24,576	$	173,919	$	—	$	443,153
Pass watch	—		—		—		508		403		6,003		—		6,914
Special mention	—		—		—		—		—		—		—		—
Substandard	—		—		—		—		—		—		—		—
Doubtful	—		—		—		—		—		—		—		—
Total municipal loans	$	65,258	$	74,617	$	57,147	$	48,144	$	24,979	$	179,922	$	—	$	450,067

Loans to individuals:
Pass	$	29,579	$	21,480	$	12,651	$	5,261	$	1,665	$	1,005	$	2,935	$	74,576
Pass watch	—		—		—		—		—		—		—		—
Special mention	—		—		—		—		—		—		—		—
Substandard	—		1		—		6		—		2		—		9
Doubtful	7		—		—		18		40		3		—		68
Total loans to individuals	$	29,586	$	21,481	$	12,651	$	5,285	$	1,705	$	1,010	$	2,935	$	74,653
Total loans	$	1,262,330	$	1,055,361	$	422,026	$	290,975	$	128,067	$	630,012	$	358,920	$	4,147,691


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

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

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

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

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

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

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

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


	December 31, 2022
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total
Real estate loans:
Construction	$	43	$	21	$	—	$	64	$	559,617	$	559,681
1-4 family residential	3,529		368		214		4,111		659,408		663,519
Commercial	105		153		415		673		1,987,034		1,987,707
Commercial loans	515		277		247		1,039		411,025		412,064
Municipal loans	—		—		—		—		450,067		450,067
Loans to individuals	203		3		40		246		74,407		74,653
Total	$	4,395	$	822	$	916	$	6,133	$	4,141,558	$	4,147,691


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

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


	December 31, 2022		December 31, 2021
Nonaccrual loans:
Real estate loans:
Construction	$	405	$	57
1-4 family residential	848		969
Commercial	762		668
Commercial loans	757		815

Loans to individuals	74		27
Total nonaccrual loans (1)	2,846		2,536

Accruing loans past due more than 90 days	—		—
TDR loans	7,849		9,073
OREO	93		—
Repossessed assets	74		—
Total nonperforming assets	$	10,862	$	11,609

(1) Includes $897,000 and $1.1 million of restructured loans as of December 31, 2022 and December 31, 2021, respectively.

We reversed $36,000 and $15,000 of interest income on nonaccrual loans during the years ended December 31, 2022 and 2021, respectively. We had $1.6 million and $1.2 million of loans on nonaccrual for which there was no related allowance for credit losses as of December 31, 2022 and 2021, respectively.

Collateral-dependent loans are loans that we expect the repayment to be provided substantially through the operation or sale of the collateral of the loan and we have determined that the borrower is experiencing financial difficulty. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for selling costs. As of December 31, 2022 and 2021, we had $8.1 million and $8.5 million, respectively, of collateral-dependent loans, secured mainly by real estate and equipment. There have been no significant changes to the collateral that secures the collateral-dependent assets. Foreclosed assets include OREO and repossessed assets. For 1-4 family residential real estate properties, a loan is recognized as a foreclosed property once legal title to the real estate property has been received upon completion of foreclosure or the borrower has conveyed all interest in the residential property through a deed in lieu of foreclosure. There were no loans secured by 1-4 family residential properties for which formal foreclosure proceedings were in process as of December 31, 2022 and $21,000 as of December 31, 2021.

Troubled Debt Restructurings

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

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


	December 31, 2022
	Extend Amortization Period		Interest Rate Reductions		Combination		Total Modifications		Number of Loans
Real estate loans:

1-4 family residential	$	—	$	—	$	305	$	305	4

Commercial loans	—		—		6		6		1
Loans to individuals	—		—		8		8		2
Total	$	—	$	—	$	319	$	319	7


	December 31, 2021
	Extend Amortization Period		Interest Rate Reductions		Combination		Total Modifications		Number of Loans
Real estate loans:

1-4 family residential	$	—	$	—	$	560	$	560	7
Commercial	—		—		450		450		1
Commercial loans	—		16		84		100		3

Total	$	—	$	16	$	1,094	$	1,110	11


	December 31, 2020
	Extend Amortization Period		Interest Rate Reductions		Combination		Total Modifications		Number of Loans
Real estate loans:


Commercial	$	—	$	—	$	58	$	58	1
Commercial loans	51		—		390		441		6
Loans to individuals	—		—		22		22		1
Total	$	51	$	—	$	470	$	521	8

Interest continues to be charged on principal balances outstanding during the extended term. Therefore, the financial effects of the recorded investment of loans restructured as TDRs during the years ended December 31, 2022 and 2021 were not significant.

On an ongoing basis, the performance of the TDRs is monitored for subsequent payment default. Payment default for TDRs is recognized when the borrower is 90 days or more past due. For the years ended December 31, 2022 and 2021 the amount of TDRs in default was $492,000 and $321,000, respectively. Payment defaults for TDRs did not significantly impact the determination of the allowance for loan losses in the periods presented.

At December 31, 2022, 2021 and 2020, there were no commitments to lend additional funds to borrowers whose terms had been modified in TDRs.

Allowance for Loan Losses

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



	Year Ended December 31, 2022
	Real Estate
	Construction		1-4 Family Residential		Commercial		Commercial Loans		Municipal Loans		Loans to Individuals		Total
Balance at beginning of period	$	3,787	$	1,866	$	26,980	$	2,397	$	47	$	196	$	35,273
Loans charged-off	—		(69)		—		(792)		—		(1,723)		(2,584)
Recoveries of loans charged-off	2		107		81		593		—		1,105		1,888
Net loans (charged-off) recovered	2		38		81		(199)		—		(618)		(696)
Provision for (reversal of) loan losses	(625)		269		1,640		37		(2)		619		1,938
Balance at end of period	$	3,164	$	2,173	$	28,701	$	2,235	$	45	$	197	$	36,515


	Year Ended December 31, 2021
	Real Estate
	Construction		1-4 Family Residential		Commercial		Commercial Loans		Municipal Loans		Loans to Individuals		Total
Balance at beginning of period	$	6,490	$	2,270	$	35,709	$	4,107	$	46	$	384	$	49,006


Loans charged-off	—		(136)		—		(1,004)		—		(1,611)		(2,751)
Recoveries of loans charged-off	2		75		87		674		—		1,142		1,980
Net loans (charged-off) recovered	2		(61)		87		(330)		—		(469)		(771)
Provision for (reversal of) loan losses	(2,705)		(343)		(8,816)		(1,380)		1		281		(12,962)
Balance at end of period	$	3,787	$	1,866	$	26,980	$	2,397	$	47	$	196	$	35,273


	Year Ended December 31, 2020
	Real Estate
	Construction		1-4 Family Residential		Commercial		Commercial Loans		Municipal Loans		Loans to Individuals		Total
Balance at beginning of period	$	3,539	$	3,833	$	9,572	$	6,351	$	570	$	932	$	24,797
Impact of CECL adoption - cumulative effect adjustment	2,968		(1,447)		7,730		(3,532)		(522)		(125)		5,072
Impact of CECL adoption - purchased loans with credit deterioration	(15)		(6)		333		(22)		—		(59)		231
Loans charged-off	(40)		(152)		(33)		(823)		—		(1,806)		(2,854)
Recoveries of loans charged-off	28		32		102		310		—		1,178		1,650
Net loans (charged-off) recovered	(12)		(120)		69		(513)		—		(628)		(1,204)
Provision for (reversal of) loan losses (1)	10		10		18,005		1,823		(2)		264		20,110
Balance at end of period	$	6,490	$	2,270	$	35,709	$	4,107	$	46	$	384	$	49,006

(1) The increase in the provision for credit losses during 2020 was primarily due to the economic impact of COVID-19 on macroeconomic factors used in the CECL methodology.

The accrued interest receivable on our loan receivables is excluded from the allowance for credit loss estimate and is included in interest receivable on our consolidated balance sheets. As of December 31, 2022 and December 31, 2021, the accrued interest on our loan portfolio was $18.8 million and $13.3 million, respectively.