UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549



FORM 10-Q



(Mark One)

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

For the quarterly period ended March 31, 2019

OR

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

For the transition period from                 to

Commission File Number: 001-38895



South Plains Financial, Inc.
(Exact name of registrant as specified in its charter)



 Texas
 
75-2453320
( State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

5219 City Bank Parkway
Lubbock, TX
 
79407
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (806) 792-7101



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

Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $1.00 par value per share
SPFI
The Nasdaq Stock Market, LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ☐    No  ☒

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
Accelerated filer
       
Non-accelerated filer
☒  (Do not check if a smaller reporting company)
Smaller reporting company
       
   
Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

As of June [6], 2019, the registrant had 17,978,520 shares of common stock, par value $1.00 per share, outstanding.



TABLE OF CONTENTS

   
Page
PART I.
3
Item 1.
3
 
3
  4
 
6
 
7
  9
Item 2.
31
Item 3.
55
Item 4.
55
PART II.
55
Item 1.
55
Item 1A.
55
Item 2.
55
Item 3.
56
Item 4.
56
Item 5.
56
Item 6.
56
56

PART I.
FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements (Unaudited)

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except per share data)

   
March 31,
2019
   
December 31,
2018
   
Pro Forma
March 31,
2019
 
ASSETS
                 
Cash and due from banks
 
$
37,632
   
$
47,802
   
$
37,632
 
Interest-bearing deposits in banks
   
301,778
     
198,187
     
301,778
 
Cash and cash equivalents
   
339,410
     
245,989
     
339,410
 
Securities available for sale
   
339,051
     
338,196
     
339,051
 
Loans held for sale
   
21,447
     
38,382
     
21,447
 
Loans held for investment
   
1,915,183
     
1,957,197
     
1,915,183
 
Allowance for loan losses
   
(23,381
)
   
(23,126
)
   
(23,381
)
Accrued interest receivable
   
9,962
     
12,957
     
9,962
 
Premises and equipment, net
   
59,572
     
59,787
     
59,572
 
Bank-owned life insurance
   
57,499
     
57,172
     
57,499
 
Other assets
   
27,254
     
26,191
     
27,254
 
Total assets
 
$
2,745,997
   
$
2,712,745
   
$
2,745,997
 
                         
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
Deposits:
                       
Noninterest-bearing
 
$
497,566
   
$
510,067
   
$
497,566
 
Interest-bearing
   
1,807,363
     
1,767,387
     
1,807,363
 
Total deposits
   
2,304,929
     
2,277,454
     
2,304,929
 
Short-term borrowings
   
18,915
     
17,705
     
18,915
 
Accrued expenses and other liabilities
   
35,723
     
29,416
     
35,723
 
Notes payable & other borrowings
   
95,000
     
95,000
     
95,000
 
Subordinated debt securities
   
26,472
     
34,002
     
26,472
 
Junior subordinated deferrable interest debentures
   
46,393
     
46,393
     
46,393
 
Total liabilities
   
2,527,432
     
2,499,970
     
2,527,432
 
Commitments and contingent liabilities
                       
ESOP owned shares
   
58,195
     
58,195
     
-
 
                         
Stockholders’ equity:
                       
Common stock, $1.00 par value per share, 30,000,000 shares authorized; 14,771,520 issued and outstanding
   
14,772
     
14,772
     
14,772
 
Additional paid-in capital
   
80,412
     
80,412
     
80,412
 
Retained earnings
   
123,328
     
119,834
     
123,328
 
Accumulated other comprehensive income (loss)
   
53
     
(2,243
)
   
53
 
     
218,565
     
212,775
     
218,565
 
Less ESOP owned shares
   
58,195
     
58,195
     
-
 
Total stockholders’ equity
   
160,370
     
154,580
     
218,565
 
Total liabilities and stockholders’ equity
 
$
2,745,997
   
$
2,712,745
   
$
2,745,997
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands, except per share data)

   
Three Months Ended March 31,
 
               
Pro Forma
 
   
2019
   
2018
   
2018
 
Interest income:
                 
Loans, including fees
 
$
28,098
   
$
24,109
   
$
24,109
 
Securities:
                       
Taxable
   
2,176
     
795
     
795
 
Non taxable
   
225
     
1,095
     
1,095
 
Federal funds sold and interest-bearing deposits in banks
   
1,505
     
1,284
     
1,284
 
Total interest income
   
32,004
     
27,283
     
27,283
 
Interest expense:
                       
Deposits
   
5,889
     
3,493
     
3,493
 
Notes payable & other borrowings
   
650
     
430
     
430
 
Subordinated debt securities
   
406
     
245
     
245
 
Junior subordinated deferrable interest debentures
   
513
     
397
     
397
 
Total interest expense
   
7,458
     
4,565
     
4,565
 
Net interest income
   
24,546
     
22,718
     
22,718
 
Provision for loan losses
   
608
     
778
     
778
 
Net interest income, after provision for loan losses
   
23,938
     
21,940
     
21,940
 
Noninterest income:
                       
Service charges on deposit accounts
   
1,905
     
1,917
     
1,917
 
Income from insurance activities
   
1,750
     
1,395
     
1,395
 
Net gain on sales of loans
   
4,660
     
4,311
     
4,311
 
Bank card services and interchange fees
   
2,010
     
1,958
     
1,958
 
Investment commissions
   
333
     
450
     
450
 
Other
   
1,417
     
1,437
     
1,437
 
Total noninterest income
   
12,075
     
11,468
     
11,468
 
Noninterest expense:
                       
Salaries and employee benefits
   
19,125
     
17,601
     
17,601
 
Occupancy and equipment, net
   
3,407
     
3,324
     
3,324
 
Professional services
   
1,706
     
1,429
     
1,429
 
Marketing and development
   
717
     
818
     
818
 
IT and data services
   
693
     
550
     
550
 
Bank card expenses
   
724
     
664
     
664
 
Appraisal expenses
   
323
     
285
     
285
 
Other
   
3,341
     
3,206
     
3,206
 
Total noninterest expense
   
30,036
     
27,877
     
27,877
 
Income before income taxes
   
5,977
     
5,531
     
5,531
 
Income tax expense
   
1,204
     
30
     
883
 
Net income
 
$
4,773
   
$
5,501
   
$
4,648
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (CONTINUED)
(Unaudited)
(Dollars in thousands, except per share data)

   
Three Months Ended March 31,
 
   
2019
   
2018
   
Pro Forma
2018
 
Earnings per share:
                 
Basic
 
$
0.32
   
$
0.37
   
$
0.31
 
Diluted
 
$
0.32
   
$
0.37
   
$
0.31
 
                         
Net income
 
$
4,773
   
$
5,501
   
$
4,648
 
                         
Other comprehensive income (loss):
                       
Change in net unrealized loss on securities available for sale
   
2,907
     
(3,160
)
   
(3,160
)
Tax effect
   
(611
)
   
-
     
664
 
Other comprehensive income (loss)
   
2,296
     
(3,160
)
   
(2,496
)
Comprehensive income
 
$
7,069
   
$
2,341
   
$
2,152
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands, except per share data)

   
Common Stock
   
Additional
Paid-in
   
Retained
   
Accumulated
Other
Comprehensive
   
Treasury
   
Less:
ESOP
Owned
       
   
Shares
   
Amount
   
Capital
   
Earnings
   
Income (Loss)
   
Stock
   
Shares
   
Total
 
                                                 
Balance at January 1, 2018
   
15,153,510
   
$
15,154
   
$
85,888
   
$
120,589
   
$
(446
)
 
$
(5,858
)
 
$
(57,121
)
 
$
158,206
 
Net income
   
-
     
-
     
-
     
5,501
     
-
     
-
     
-
     
5,501
 
Cash dividends:
                                                               
Common - $0.15 per share
   
-
     
-
     
-
     
(2,215
)
   
-
     
-
     
-
     
(2,215
)
Other comprehensive (loss), (net of tax)
   
-
     
-
     
-
     
-
     
(3,160
)
   
-
     
-
     
(3,160
)
                                                                 
Balance at March 31, 2018
   
15,153,510
   
$
15,154
   
$
85,888
   
$
123,875
   
$
(3,606
)
 
$
(5,858
)
 
$
(57,121
)
 
$
158,332
 
                                                                 
Balance at January 1, 2019
   
14,771,520
   
$
14,772
   
$
80,412
   
$
119,834
   
$
(2,243
)
 
$
-
   
$
(58,195
)
 
$
154,580
 
Net income
   
-
     
-
     
-
     
4,773
     
-
     
-
     
-
     
4,773
 
Other comprehensive income, (net of tax)
   
-
     
-
     
-
     
-
     
2,296
     
-
     
-
     
2,296
 
Cumulative change in accounting principle
   
-
     
-
     
-
     
(1,279
)
   
-
     
-
     
-
     
(1,279
)
                                                                 
Balance at March 31, 2019
   
14,771,520
   
$
14,772
   
$
80,412
   
$
123,328
   
$
53
   
$
-
   
$
(58,195
)
 
$
160,370
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)

   
For the Three Months Ended March 31,
 
   
2019
   
2018
 
             
Cash flows from operating activities:
           
Net income
 
$
4,773
   
$
5,501
 
Adjustments to reconcile net income to net cash from operating activities:
               
Provision for loan losses
   
608
     
778
 
Depreciation and amortization
   
1,252
     
1,328
 
Accretion and amortization
   
(308
)
   
637
 
Other gains, net
   
(3
)
   
(95
)
Net gain on sales of loans
   
(4,660
)
   
(4,311
)
Proceeds from sales of loans held for sale
   
142,435
     
115,615
 
Loans originated for sale
   
(120,840
)
   
(108,797
)
Earnings on bank-owned life insurance
   
(327
)
   
(333
)
Net change in:
               
Accrued interest receivable and other assets
   
1,371
     
3,970
 
Accrued expenses and other liabilities
   
5,028
     
1,323
 
Net cash from operating activities
   
29,329
     
15,616
 
                 
Cash flows from investing activities:
               
Activity in securities available for sale:
               
Purchases
   
(5,192
)
   
-
 
Maturities, prepayments, and calls
   
7,552
     
7,299
 
Activity in securities held to maturity:
               
Maturities, prepayments, and calls
   
-
     
14,675
 
Loan originations and principal collections, net
   
41,201
     
12,924
 
Purchases of premises and equipment, net
   
(1,032
)
   
(746
)
Proceeds from sales of premises and equipment
   
3
     
20
 
Proceeds from sales of foreclosed assets
   
405
     
1,035
 
Net cash from investing activities
   
42,937
     
35,207
 
                 
Cash flows from financing activities:
               
Net change in deposits
   
27,475
     
5,240
 
Net change in short-term borrowings
   
1,210
     
5,070
 
Payments made on notes payable and other borrowings
   
(7,530
)
   
-
 
Cash dividends on common stock
   
-
     
(2,215
)
Net cash from financing activities
   
21,155
     
8,095
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Unaudited)
(Dollars in thousands)

   
For the Three Months Ended March 31,
 
   
2019
   
2018
 
             
Net change in cash and cash equivalents
 
$
93,421
   
$
58,918
 
Beginning cash and cash equivalents
   
245,989
     
294,563
 
Ending cash and cash equivalents
 
$
339,410
   
$
353,481
 
                 
Supplemental disclosures of cash flow information:
               
Interest paid on deposits and borrowed funds
 
$
7,140
   
$
3,443
 
Income taxes paid
   
-
     
-
 
Supplemental schedule of noncash investing and financing activities:
               
Loans transferred to foreclosed assets
  $
460
    $
804
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations – South Plains Financial, Inc. (“SPFI”) is a Texas bank holding company that conducts its principal activities through its subsidiaries from offices located throughout Texas and Eastern New Mexico.  Principal activities include commercial and retail banking, along with insurance, investment, trust, and mortgage services.  Subsidiaries of SPFI follow:

Wholly Owned, Consolidated Subsidiaries:
 
City Bank
Bank subsidiary
Windmark Insurance Agency, Inc.
Non-bank subsidiary
Ruidoso Retail, Inc.
Non-bank subsidiary
CB Provence, LLC
Non-bank subsidiary
CBT Brushy Creek, LLC
Non-bank subsidiary
CBT Properties, LLC
Non-bank subsidiary
Wholly Owned, Equity Method Subsidiaries:
 
South Plains Financial Capital Trusts (SPFCT) III-V
Non-bank subsidiaries

Basis of Presentation and Consolidation – The consolidated financial statements in this Quarterly Report on Form 10-Q (“Report”) include the accounts of SPFI and its wholly owned consolidated subsidiaries (collectively referred to as the “Company”) identified above.  All significant intercompany balances and transactions have been eliminated in consolidation.

The interim consolidated financial statements in this Report have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s financial position and results of operations. All such adjustments were of a normal and recurring nature.  The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”).  Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Company’s consolidated financial statements, and notes thereto, for the year ended December 31, 2018 in our prospectus filed with the SEC pursuant to Rule 424(b) of the Securities Act of 1933, as amended, on May 9, 2019.  Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

Use of Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Determination of the adequacy of the allowance for loan losses is a material estimate that is particularly susceptible to significant change in the near term; the valuation of foreclosed assets and fair values of financial instruments can also involve significant management estimates.

Change in Capital Structure
On March 11, 2019, the Company amended and restated its Certificate of Formation.  The original Certificate of Formation was amended to change the capital structure to authorize the issuance of 30,000,000 shares of common stock, par value $1.00 per share.

The Company completed a 29-to-1 stock split of the Company’s outstanding shares of common stock for shareholders of record as of March 11, 2019.  The stock split was payable in the form of a dividend on or about March 11, 2019.  Shareholders received 29 additional shares for each share held as of the record date.  All share and per share amounts in the consolidated financial statements have been retroactively adjusted to reflect this stock split for all periods presented.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

Pro Forma Information – As a result of the revocation of the S corporation election effective May 31, 2018, the net income and earnings per share data prior to that date are not comparable with subsequent periods, which include federal income tax expense.  As a result, the consolidated statements of comprehensive income in this Report includes a pro forma column for the period ended March 31, 2018, as if the conversion to a C corporation had occurred effective January 1, 2018.  The federal tax rate used is 21%.

In accordance with applicable provisions of the Internal Revenue Code, the terms of our employee stock ownership plan (“ESOP”), provided that, for so long as we were a privately held company, ESOP participants would have the right, for a specified period of time, to require us to repurchase shares of our common stock that are distributed to them by the ESOP.  This repurchase obligation terminated upon the consummation of our initial public offering and listing of our common stock on the NASDAQ Global Select Market in May 2019. However, because we were privately held during the periods covered by the Report, the shares of common stock held by the ESOP are reflected in our consolidated balance sheets as a line item called ESOP-owned shares, appearing between total liabilities and stockholders’ equity. As a result, the value of ESOP-owned shares are deducted from stockholders’ equity in our consolidated balance sheet for the periods included in this Report. The consolidated balance sheet in this Report includes a pro forma column, which assumes that the ESOP repurchase obligation has terminated as of the date presented in the Report. For all periods following our initial public offering and continued listing of our common stock on the NASDAQ Global Select Market, the ESOP-owned shares will be included in, and not be deducted from, stockholders’ equity.

Change in Accounting Principle – Prior to January 1, 2019, the Company accounted for its cash-settled stock appreciation rights (“SARs”) using the intrinsic value method, as permitted by ASC 718.  As a result of the Company filing its prospectus with the SEC, the Company is now required to use the fair value method for these SARs.  The Company’s calculation of the fair value of the SARs, as of January 1, 2019, exceeded the recorded intrinsic value by $1.6 million.  ASC 250 states that an “entity shall report a change in accounting principle through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so”.  Retrospective application of the effects of a change from the intrinsic value to fair value would be impracticable due to the need to objectively determine assumptions that would be used in prior periods without using current information.  Additionally, SAB Topic 14.B states that entities changing from nonpublic to public status are not permitted to apply the fair-value-based method retrospectively.  Therefore, the Company recorded a cumulative-effect adjustment to retained earnings for $1.3 million ($1.6 million net of $340,000 in tax) effective January 1, 2019 and applied this change prospectively.

Stock-based Compensation – The Company sponsors an equity incentive plan under which options to acquire shares of Company common stock may be granted periodically to all full-time employees and directors of the Company or its affiliates at a specific exercise price to acquire shares of the Company’s common stock. Shares are issued out of authorized unissued common shares. Compensation cost is measured based on the estimated fair value of the award at the grant date and is recognized in earnings on a straight-line basis over the requisite service period. The fair value of stock options is estimated at the date of grant using the Black-Scholes option pricing model. This model requires assumptions as to the expected stock volatility, dividends, terms and risk-free rates. The expected volatility is based on the combination of the Company’s historical volatility and the volatility of comparable peer banks. The expected term represents the period of time that options are expected to be outstanding from the grant date. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the appropriate life of each stock option.

Recent Accounting PronouncementsFinancial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) constitutes U.S. GAAP for nongovernmental entities. Updates to ASC are prescribed in Accounting Standards Updates (“ASU”), which are not authoritative until incorporated into ASC.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

ASU 2016-01 Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.  ASU 2016-01, among other things, eliminates the requirement to disclose the fair value of financial instruments at amortized cost for entities that are not public business entities. We originally adopted the new standard effective January 1, 2018, the effective date of the guidance. Accordingly, the Company’s fair value of financial instruments at amortized cost were not disclosed in our consolidated financial statements for 2018.  However, based on the Company becoming a public company, these disclosures are now required and have been included in our consolidated financial statements.

ASU 2016-13 Financial Instruments - Credit Losses (Topic 326).  The FASB issued guidance to replace the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (“CECL”) model.  The CECL model is applicable to the measurement of credit losses on financial assets measured at amortized cost, including loan receivables, held to maturity securities,  and debt securities. ASU 2016-13 is effective for the Company for annual periods beginning after December 15, 2021, including interim periods within those fiscal years. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is currently evaluating the impact adoption of ASU 2016-13 will have on its consolidated operating results and financial condition.

2.
SECURITIES

The amortized cost and fair value of securities, with gross unrealized gains and losses, at period-end follow:

   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
                         
March 31, 2019
                       
Available for sale:
                       
U.S. government and agencies
 
$
85,217
   
$
26
   
$
(42
)
 
$
85,201
 
State and municipal
   
32,118
     
566
     
(163
)
   
32,521
 
Mortgage-backed securities
   
182,684
     
1,092
     
(992
)
   
182,784
 
Asset-backed and other amortizing securities
   
38,965
     
33
     
(453
)
   
38,545
 
                                 
   
$
338,984
   
$
1,717
   
$
(1,650
)
 
$
339,051
 

   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
                         
December 31, 2018
                       
Available for sale:
                       
U.S. government and agencies
 
$
84,765
   
$
18
   
$
(76
)
 
$
84,707
 
State and municipal
   
32,205
     
480
     
(375
)
   
32,310
 
Mortgage-backed securities
   
184,267
     
29
     
(2,040
)
   
182,256
 
Asset-backed and other amortizing securities
   
39,799
     
1
     
(877
)
   
38,923
 
                                 
   
$
341,036
   
$
528
   
$
(3,368
)
 
$
338,196
 

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

The amortized cost and fair value of debt securities at March 31, 2019 are presented below by contractual maturity.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.  Other securities are shown separately since they are not due at a single maturity date.

   
Available for Sale
 
   
Amortized
Cost
   
Fair
Value
 
             
Within 1 year
 
$
78,370
   
$
78,356
 
After 1 year through 5 years
   
7,317
     
7,318
 
After 5 years through 10 years
   
12,006
     
11,997
 
After 10 years
   
19,642
     
20,051
 
Other
   
221,649
     
221,329
 
                 
   
$
338,984
   
$
339,051
 

At March 31, 2019 and December 31, 2018, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

Securities with a carrying value of approximately $206.4 million and $200.0 million at March 31, 2019 and December 31, 2018, respectively, were pledged to collateralize public deposits and for other purposes as required or permitted by law.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

The following table segregates securities with unrealized losses at the periods indicated, by the duration they have been in a loss position:

   
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
 
March 31, 2019
                                   
U.S. government and agencies
 
$
74,872
   
$
9
   
$
5,553
   
$
33
   
$
80,425
   
$
42
 
State and municipal
   
918
     
1
     
13,443
     
162
     
14,361
     
163
 
Mortgage-backed securities
   
-
     
-
     
53,083
     
992
     
53,083
     
992
 
Asset-backed and other amortizing securities
   
-
     
-
     
34,060
     
453
     
34,060
     
453
 
                                                 
   
$
75,790
   
$
10
   
$
106,139
   
$
1,640
   
$
181,929
   
$
1,650
 
                                                 
December 31, 2018
                                               
U.S. government and agencies
 
$
77,891
   
$
27
   
$
2,048
   
$
49
   
$
79,939
   
$
76
 
State and municipal
   
5,662
     
92
     
9,781
     
283
     
15,443
     
375
 
Mortgage-backed securities
   
108,962
     
293
     
54,035
     
1,747
     
162,997
     
2,040
 
Asset-backed and other amortizing securities
   
-
     
-
     
37,351
     
877
     
37,351
     
877
 
                                                 
   
$
192,515
   
$
412
   
$
103,215
   
$
2,956
   
$
295,730
   
$
3,368
 

There were 65 securities with an unrealized loss at March 31, 2019.  Management does not believe that these losses are other than temporary as there is no intent to sell any of these securities before recovery and it is not probable that we will be required to sell any of these securities before recovery, and credit loss, if any, is not material.  Any unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased.  The fair value is expected to recover as the securities approach their maturity date or if market yields for such investments decline.  Management does not believe any of the securities are impaired due to reasons of credit quality.  Accordingly, as of March 31, 2019, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Company’s consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

3.
LOANS

Loans are summarized by category as follows:

   
March 31,
2019
   
December 31,
2018
 
             
Commercial real estate
 
$
528,598
   
$
538,037
 
Commercial - specialized
   
258,975
     
305,022
 
Commercial - general
   
413,093
     
427,728
 
Consumer:
               
1-4 family residential
   
354,981
     
346,153
 
Auto loans
   
200,366
     
191,647
 
Other consumer
   
71,939
     
70,209
 
Construction
   
87,231
     
78,401
 
                 
     
1,915,183
     
1,957,197
 
Allowance for loan losses
   
(23,381
)
   
(23,126
)
                 
Loans, net
 
$
1,891,802
   
$
1,934,071
 

The Company has certain lending policies, underwriting standards, and procedures in place that are designed to maximize loan income with an acceptable level of risk. Management reviews and approves these policies, underwriting standards, and procedures on a regular basis and makes changes as appropriate. Management receives frequent reports related to loan originations, quality, concentrations, delinquencies, non-performing, and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions, both by type of loan and geography.

Commercial – General and Specialized – Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably. Underwriting standards have been designed to determine whether the borrower possesses sound business ethics and practices, evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations, as agreed and ensure appropriate collateral is obtained to secure the loan. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as real estate, accounts receivable, or inventory, and include personal guarantees.  Owner-occupied real estate is included in commercial loans, as the repayment of these loans is generally dependent on the operations of the commercial borrower’s business rather than on income-producing properties or the sale of the properties.  Commercial loans are grouped into two distinct sub-categories: specialized and general. Commercial related segments that are considered “specialized” include agricultural production and real estate loans, energy loans, and finance, investment, and insurance loans. Commercial related segments that contain a broader diversity of borrowers, sub-industries, or serviced industries are grouped into the “general category.” These include goods, services, restaurant & retail, construction, and other industries.

Commercial Real Estate – Commercial real estate loans are also subject to underwriting standards and processes similar to commercial loans. These loans are underwritten primarily based on projected cash flows for income-producing properties and collateral values for nonincome-producing properties. The repayment of these loans is generally dependent on the successful operation of the property securing the loans or the sale or refinancing of the property. Real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are diversified by type and geographic location. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry.

Construction – Loans for residential construction are for single-family properties to developers, builders, or end-users.  These loans are underwritten based on estimates of costs and completed value of the project.  Funds are advanced based on estimated percentage of completion for the project.  Performance of these loans is affected by economic conditions as well as the ability to control costs of the projects.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

Consumer – Loans to consumers include 1-4 family residential loans, auto loans, and other loans for recreational vehicles or other purposes. The Company utilizes a computer-based credit scoring analysis to supplement its policies and procedures in underwriting consumer loans. The Company’s loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimize the Company’s risk.  The Company generally requires mortgage title insurance and hazard insurance on 1-4 family residential loans.

The following table details the activity in the allowance for loan losses.  Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

   
Beginning
Balance
   
Provision for
loan losses
   
Charge-offs
   
Recoveries
   
Ending
Balance
 
For the three months ended
                             
March 31, 2019
                             
Commercial real estate
 
$
5,579
   
$
(352
)
 
$
-
   
$
108
   
$
5,335
 
Commercial - specialized
   
2,516
     
(179
)
   
(33
)
   
23
     
2,327
 
Commercial - general
   
8,173
     
262
     
(4
)
   
73
     
8,504
 
Consumer:
                                       
1-4 family residential
   
2,249
     
156
     
(19
)
   
30
     
2,416
 
Auto loans
   
2,994
     
299
     
(259
)
   
33
     
3,067
 
Other consumer
   
1,192
     
212
     
(279
)
   
49
     
1,174
 
Construction
   
423
     
210
     
(75
)
   
-
     
558
 
                                         
Total
 
$
23,126
   
$
608
   
$
(669
)
 
$
316
   
$
23,381
 

                               
For the three months ended
                             
March 31, 2018
                             
Commercial real estate
 
$
3,769
   
$
1,360
   
$
-
   
$
-
   
$
5,129
 
Commercial - specialized
   
2,367
     
265
     
(38
)
   
56
     
2,650
 
Commercial - general
   
10,151
     
(1,313
)
   
(100
)
   
187
     
8,925
 
Consumer:
                                       
1-4 family residential
   
1,787
     
(359
)
   
(1
)
   
-
     
1,427
 
Auto loans
   
2,068
     
521
     
(235
)
   
32
     
2,386
 
Other consumer
   
971
     
253
     
(207
)
   
36
     
1,053
 
Construction
   
348
     
51
     
-
     
-
     
399
 
                                         
Total
 
$
21,461
   
$
778
   
$
(581
)
 
$
311
   
$
21,969
 

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

The following table shows the Company’s investment in loans disaggregated based on the method of evaluating impairment:

   
Recorded Investment
   
Allowance for Loan Losses
 
   
Individually
Evaluated
   
Collectively
Evaluated
   
Individually
Evaluated
   
Collectively
Evaluated
 
                         
March 31, 2019
                       
Commercial real estate
 
$
473
   
$
528,125
   
$
-
   
$
5,335
 
Commercial - specialized
   
2,045
     
256,930
     
68
     
2,259
 
Commercial - general
   
2,856
     
410,237
     
335
     
8,169
 
Consumer:
                               
1-4 family residential
   
2,590
     
352,391
     
120
     
2,296
 
Auto loans
   
-
     
200,366
     
-
     
3,067
 
Other consumer
   
-
     
71,939
     
-
     
1,174
 
Construction
   
702
     
86,529
     
60
     
498
 
                                 
Total
 
$
8,666
   
$
1,906,517
   
$
583
   
$
22,798
 
                                 
December 31, 2018
                               
Commercial real estate
 
$
1,819
   
$
536,218
   
$
-
   
$
5,579
 
Commercial - specialized
   
2,116
     
302,906
     
-
     
2,516
 
Commercial - general
   
2,950
     
424,778
     
233
     
7,940
 
Consumer:
                               
1-4 family residential
   
2,475
     
343,678
     
8
     
2,241
 
Auto loans
   
-
     
191,647
     
-
     
2,994
 
Other consumer
   
-
     
70,209
     
-
     
1,192
 
Construction
   
-
     
78,401
     
-
     
423
 
                                 
Total
 
$
9,360
   
$
1,947,837
   
$
241
   
$
22,885
 

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

Impaired loan information follows:

   
Unpaid
Contractual
Principal
Balance
   
Recorded
Investment
With No
Allowance
   
Recorded
Investment
With
Allowance
   
Total
Recorded
Investment
   
Related
Allowance
   
Average
Recorded
Investment
 
                                     
March 31, 2019
                                   
Commercial real estate
 
$
928
   
$
473
   
$
-
   
$
473
   
$
-
   
$
1,146
 
Commercial - specialized
   
2,045
     
1,359
     
686
     
2,045
     
68
     
2,081
 
Commercial - general
   
4,664
     
180
     
2,676
     
2,856
     
335
     
2,903
 
Consumer:
                                               
1-4 family
   
3,009
     
2,131
     
459
     
2,590
     
120
     
2,533
 
Auto loans
   
-
     
-
     
-
     
-
     
-
     
-
 
Other consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Construction
   
777
     
345
     
357
     
702
     
60
     
351
 
                                                 
Total
 
$
11,423
   
$
4,488
   
$
4,178
   
$
8,666
   
$
583
   
$
9,014
 
                                                 
December 31, 2018
                                               
Commercial real estate
 
$
2,274
   
$
1,819
   
$
-
   
$
1,819
   
$
-
   
$
4,590
 
Commercial - specialized
   
2,116
     
2,116
     
-
     
2,116
     
-
     
3,742
 
Commercial - general
   
4,758
     
240
     
2,710
     
2,950
     
233
     
3,963
 
Consumer:
                                               
1-4 family
   
2,894
     
2,111
     
364
     
2,475
     
8
     
2,881
 
Auto loans
   
-
     
-
     
-
     
-
     
-
     
-
 
Other consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Construction
   
-
     
-
     
-
     
-
     
-
     
-
 
                                                 
Total
 
$
12,042
   
$
6,286
   
$
3,074
   
$
9,360
   
$
241
   
$
15,176
 

All impaired loans $250,000 and greater were specifically evaluated for impairment.  Interest income recognized using a cash-basis method on impaired loans for the period ended March 31, 2019 and the year ended December 31, 2018 was not significant.  Additional funds committed to be advanced on impaired loans are not significant.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

The table below provides an age analysis on accruing past-due loans and nonaccrual loans:

   
30-89 Days Past
Due
   
90 Days or
More Past Due
   
Nonaccrual
 
                   
March 31, 2019
                 
Commercial real estate
 
$
1,493
   
$
-
   
$
200
 
Commercial - specialized
   
402
     
-
     
2,753
 
Commercial - general
   
2,432
     
-
     
2,170
 
Consumer:
                       
1-4 Family residential
   
1,839
     
186
     
1,831
 
Auto loans
   
808
     
33
         
Other consumer
   
683
     
61
         
Construction
   
646
     
-
     
703
 
                         
Total
 
$
8,303
   
$
280
   
$
7,657
 
                         
December 31, 2018
                       
Commercial real estate
 
$
1,748
   
$
-
   
$
217
 
Commercial - specialized
   
992
     
-
     
2,550
 
Commercial - general
   
2,625
     
-
     
2,134
 
Consumer:
                       
1-4 Family residential
   
1,611
     
440
     
1,489
 
Auto loans
   
825
     
50
         
Other consumer
   
883
     
74
         
Construction
   
-
     
-
     
-
 
                         
Total
 
$
8,684
   
$
564
   
$
6,390
 

The Company grades its loans on a thirteen-point grading scale.  These grades fit in one of the following categories:  (i) pass, (ii) special mention, (iii) substandard, (iv) doubtful, or (v) loss.  Loans categorized as loss are charged-off immediately.  The grading of loans reflect a judgment about the risks of default associated with the loan. The Company reviews the grades on loans as part of our on-going monitoring of the credit quality of our loan portfolio.

Pass loans have financial factors or nature of collateral that are considered reasonable credit risks in the normal course of lending and encompass several grades that are assigned based on varying levels of risk, ranging from credits that are secured by cash or marketable securities, to watch credits which have all the characteristics of an acceptable credit risk but warrant more than the normal level of monitoring.

Special mention loans have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of repayment prospects for the loans at some future date.

Substandard loans are inadequately protected by the current net worth and paying capacity of the borrower or by the collateral pledged, if any.  These loans have a well-defined weakness or weaknesses that jeopardize collection and present the distinct possibility that some loss will be sustained if the deficiencies are not corrected.  A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.  Substandard loans can be accruing or can be nonaccrual depending on the circumstances of the individual loans.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

Doubtful loans have all the weaknesses inherent in substandard loans with the added characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable.  All doubtful loans are on nonaccrual.

The following table summarizes the internal classifications of loans:

   
Pass
   
Special
Mention
   
Substandard
   
Doubtful
   
Total
 
                               
March 31, 2019
                             
Commercial real estate
 
$
503,424
   
$
19,919
   
$
5,255
   
$
-
   
$
528,598
 
Commercial - specialized
   
255,433
     
-
     
3,542
     
-
     
258,975
 
Commercial - general
   
400,960
     
1,375
     
10,758
     
-
     
413,093
 
Consumer:
                                       
1-4 family residential
   
349,532
     
-
     
5,449
     
-
     
354,981
 
Auto loans
   
200,129
     
-
     
237
     
-
     
200,366
 
Other consumer
   
71,766
     
-
     
173
     
-
     
71,939
 
Construction
   
86,529
     
-
     
702
     
-
     
87,231
 
                                         
Total
 
$
1,867,773
   
$
21,294
   
$
26,116
   
$
-
   
$
1,915,183
 
                                         
December 31, 2018
                                       
Commercial real estate
 
$
514,249
   
$
17,300
   
$
6,488
   
$
-
   
$
538,037
 
Commercial - specialized
   
301,289
     
-
     
3,733
     
-
     
305,022
 
Commercial - general
   
415,675
     
1,449
     
10,604
     
-
     
427,728
 
Consumer:
                                       
1-4 family residential
   
340,836
     
-
     
5,317
     
-
     
346,153
 
Auto loans
   
191,435
     
-
     
212
     
-
     
191,647
 
Other consumer
   
70,075
     
-
     
134
     
-
     
70,209
 
Construction
   
78,401
     
-
     
-
     
-
     
78,401
 
                                         
Total
 
$
1,911,960
   
$
18,749
   
$
26,488
   
$
-
   
$
1,957,197
 

There were no loans restructured as troubled debt restructurings during the three-month period ended March 31, 2019 and the year ended December 31, 2018.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

4.
BORROWING ARRANGEMENTS

Subordinated debt securities
In January 2014, the Company issued $20.9 million in subordinated debt securities.   These securities pay interest quarterly and mature January 2024.  There was $6.5 million issued at a current rate of 4% and $14.4 million at a current rate of 5%.  These rates were fixed for five years and then float at Wall Street Journal prime, with a floor of 4% and a ceiling of 7.5%.  These securities are unsecured and could be called by the Company at any time after January 2019, they qualified for Tier 2 capital treatment, subject to regulatory limitations.  In December 2018, the Company notified all holders that it intended to call these securities in January of 2019 and were given the option to subscribe to a new offering (see following paragraph) or to be redeemed.  Holders of $13.4 million elected to subscribe to the new offering while holders of $7.5 million elected to have their securities redeemed in January 2019.  As a result, these securities had been fully redeemed as of March 31, 2019, while the outstanding balance of these securities at December 31, 2018 was $7.5 million.

In December 2018, the Company issued $26.5 million in subordinated debt securities.  $12.4 million of the securities have a maturity date of December 2028 and an average fixed rate of 5.74% for the first five years.  The remaining $14.1 million of securities have a maturity date of December 2030 and an average fixed rate of 6.41% for the first seven years.  After the fixed rate periods, all securities will float at the Wall Street Journal prime rate, with a floor of 4.5% and a ceiling of 7.5%.  These securities pay interest quarterly, are unsecured, and may be called by the Company at any time after the remaining maturity is five years or less.  Additionally, these securities qualify for Tier 2 capital treatment, subject to regulatory limitations.

5.
EMPLOYEE BENEFITS

Non-Qualified Plans - Certain Company executives, as determined by the Company’s Board of Directors from time-to-time, were granted SARs based on grant date values.  The rights have varying vesting provisions.  Exercise and payment options for the rights vary and are governed by the program they were issued under as well as the specific award agreement.  Prior to January 1, 2019, the Company accrued the liabilities for these rights under the intrinsic value method.  The accrual for the liabilities was $10.6 million at December 31, 2018.

As a result of the Company becoming a reporting company with the SEC, the Company is now required to use the fair value method for these SARs.  The Company’s calculation of the fair value of the SARs, as of January 1, 2019, exceeded the recorded intrinsic value by $1.6 million.  Therefore, the Company recorded a cumulative-effect adjustment to retained earnings for $1.3 million ($1.6 million net of $340,000 in tax) effective January 1, 2019 and applied this change prospectively.

The Company recorded expense of $607,000 for the increase in the intrinsic value of the SARs, prior to the change to the fair value method, and the change in fair value of the SARs at March 31, 2019.

6.
STOCK-BASED COMPENSATION

Equity Incentive Plan
The 2019 Equity Incentive Plan (“Plan”) was approved by the Company’s Board of Directors on January 16, 2019 and by its shareholders on March 6, 2019.  The purpose of this Plan is to: (i) attract and retain the best available personnel for positions of substantial responsibility, (ii) provide additional incentive to employees, directors and consultants, and (iii) promote the success of the Company’s business. This Plan permits the grant of incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, performance shares, and other stock-based awards.  The maximum aggregate number of shares of common stock that may be issued pursuant to all awards under the Plan is 2,300,000. The maximum aggregate number of shares that may be issued under the Plan may be increased annually by up to 3% of the total issued and outstanding common shares of the Company at the beginning of each fiscal year.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands except per share data)

The fair value of each option award is estimated on the date of grant using a closed form option valuation (“Black-Scholes”) model that uses the assumptions noted in the table below.  Expected volatilities are based on historical volatilities of the Company’s common stock and similar peer company averages.  The Company uses historical data to estimate option exercise and post-vesting termination behavior.  The expected term of options granted represents the period of time that options granted are expected to be outstanding, which takes in to account that the options are not transferable.  The risk-free interest rate for the expected term of the option is based on U.S. Treasury yield curve in effect at the time of the grant.

Options
A summary of activity in the Plan during the three months ended March 31, 2019:

   
Number
of Shares
   
Weighted-
Average
Exercise Price
   
Weighted-
Average
Remaining
Contractual
Life in Years
   
Aggregate
Intrinsic
Value
 
                         
Three Months Ended March 31, 2019
                       
Outstanding at beginning of year:
   
-
   
$
-
     
-
   
$
-
 
Granted
   
10,342
     
21.32
     
9.97
     
-
 
Exercised
   
-
     
-
     
-
     
-
 
Forfeited
   
-
     
-
     
-
     
-
 
                                 
Balance, March 31, 2019
   
10,342
   
$
21.32
     
9.97
   
$
-
 
                                 
Exercisable at end of period
   
-
   
$
-
     
-
   
$
-
 
                                 
Vested at end of period
   
-
   
$
-
     
-
   
$
-
 

A summary of assumptions used to calculate the fair values of the awards is presented below:

   
Three Months
Ended March
31, 2019