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Independent Bank Group, Inc. - Quarter Report: 2017 September (Form 10-Q)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549   

FORM 10-Q(Mark One)
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended September 30, 2017.
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 001-35854
Independent Bank Group, Inc.
(Exact name of registrant as specified in its charter)   
Texas
   
13-4219346
(State or other jurisdiction of incorporation or organization)
   
(I.R.S. Employer Identification No.)
   
   
   
1600 Redbud Boulevard, Suite 400
McKinney, Texas
   
75069-3257
(Address of principal executive offices)
   
(Zip Code)
(972) 562-9004
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)

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 such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See 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
   
ý
Non-accelerated filer
   
¨
(Do not check if a smaller reporting company)
 
 
 
 
 
 
 
Smaller reporting company
   
¨
 
 
 
 
 
Emerging growth company
 
ý
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ý
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
Applicable Only to Corporate Issuers
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
Common Stock, Par Value $0.01 Per Share – 27,806,877 shares as of October 25, 2017.





INDEPENDENT BANK GROUP, INC. AND SUBSIDIARIES
Form 10-Q
September 30, 2017
   
PART I.
 
 
   
   
   
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   
   
 
 
Item 2.
 
   
   
   
 
Item 3.
 
   
   
   
 
Item 4.
 
   
   
   
 
PART II.
 
 
   
   
   
 
Item 1.
   
   
   
   
 
Item 1A.
   
   
   
   
 
Item 2
   
   
   
   
 
Item 3.
   
   
   
   
 
Item 4.
   
   
   
 
 
Item 5.
   
   
   
   
 
Item 6.
   
   
   
   
 
   
 
 
   


***






Independent Bank Group, Inc. and Subsidiaries

Consolidated Balance Sheets
September 30, 2017 (unaudited) and December 31, 2016
(Dollars in thousands, except share information)
   
 
September 30,
 
December 31,
Assets
 
2017
 
2016
   
 
   
 
   
Cash and due from banks
 
$
268,498

 
$
158,686

Interest-bearing deposits in other banks
 
484,519

 
336,341

Federal funds sold
 
10,000

 
10,000

Cash and cash equivalents
 
763,017

 
505,027

Certificates of deposit held in other banks
 
15,692

 
2,707

Securities available for sale, at fair value
 
747,147

 
316,435

Loans held for sale
 
25,854

 
9,795

Loans, net
 
6,324,545

 
4,539,063

Premises and equipment, net
 
155,741

 
89,898

Other real estate owned
 
10,189

 
1,972

Federal Home Loan Bank (FHLB) of Dallas stock and other restricted stock
 
29,046

 
26,536

Bank-owned life insurance (BOLI)
 
112,381

 
57,209

Deferred tax asset
 
21,033

 
9,631

Goodwill
 
606,701

 
258,319

Core deposit intangible, net
 
47,198

 
14,177

Other assets
 
32,570

 
22,032

Total assets
 
$
8,891,114

 
$
5,852,801

 
 
 
 
 
Liabilities and Stockholders’ Equity
 
   
 
   
Deposits:
 
   
 
   
Noninterest-bearing
 
$
1,939,342

 
$
1,117,927

Interest-bearing
 
4,933,289

 
3,459,182

Total deposits
 
6,872,631

 
4,577,109

 
 
 
 
 
FHLB advances
 
560,687

 
460,746

Repurchase agreements
 
15,238

 

Other borrowings
 
107,567

 
107,299

Junior subordinated debentures
 
27,604

 
18,147

Other liabilities
 
25,927

 
17,135

Total liabilities
 
7,609,654

 
5,180,436

Commitments and contingencies
 


 


Stockholders’ equity:
 
   
 
   
Preferred stock (0 and 0 shares outstanding, respectively)
 

 

Common stock (27,804,877 and 18,870,312 shares outstanding, respectively)
 
278

 
189

Additional paid-in capital
 
1,109,884

 
555,325

Retained earnings
 
167,820

 
117,951

Accumulated other comprehensive income (loss)
 
3,478

 
(1,100
)
Total stockholders’ equity
 
1,281,460

 
672,365

Total liabilities and stockholders’ equity
 
$
8,891,114

 
$
5,852,801

See Notes to Consolidated Financial Statements

1





Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Income
Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands, except per share information)
   
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
   
 
2017
 
2016
 
2017
 
2016
Interest income:
 
 
 
 
 
   
 
   
Interest and fees on loans
 
$
79,325

 
$
51,194

 
$
208,263

 
$
151,522

Interest on taxable securities
 
2,539

 
573

 
5,606

 
2,067

Interest on nontaxable securities
 
1,124

 
394

 
2,657

 
1,289

Interest on interest-bearing deposits and other
 
1,684

 
579

 
3,968

 
1,267

Total interest income
 
84,672

 
52,740

 
220,494

 
156,145

Interest expense:
 
 
 
 
 
   
 
 
Interest on deposits
 
8,033

 
4,049

 
20,043

 
11,623

Interest on FHLB advances
 
1,749

 
1,063

 
4,271

 
3,062

Interest on repurchase agreements and other borrowings
 
1,716

 
1,733

 
5,137

 
3,723

Interest on junior subordinated debentures
 
317

 
158

 
819

 
457

Total interest expense
 
11,815

 
7,003

 
30,270

 
18,865

Net interest income
 
72,857

 
45,737

 
190,224

 
137,280

Provision for loan losses
 
1,873

 
2,123

 
6,368

 
7,243

Net interest income after provision for loan losses
 
70,984

 
43,614

 
183,856

 
130,037

Noninterest income:
 
 
 
 
 
   
 
 
Service charges on deposit accounts
 
3,677

 
1,840

 
9,364

 
5,287

Mortgage fee income
 
4,569

 
1,922

 
10,855

 
5,319

Gain on sale of loans
 
351

 

 
351

 

Loss on sale of branch
 
(127
)
 
(43
)
 
(127
)
 
(43
)
Gain (loss) on sale of other real estate
 

 
4

 
(36
)
 
57

Gain on sale of securities available for sale
 

 

 
52

 
4

(Loss) gain on sale of premises and equipment
 
(21
)
 
(9
)
 
(15
)
 
32

Increase in cash surrender value of BOLI
 
778

 
402

 
1,959

 
937

Other
 
2,903

 
816

 
5,305

 
2,738

Total noninterest income
 
12,130

 
4,932

 
27,708

 
14,331

Noninterest expense:
 
 
 
 
 
   
 
 
Salaries and employee benefits
 
25,684

 
15,303

 
69,610

 
51,644

Occupancy
 
6,380

 
4,038

 
16,399

 
12,119

Data processing
 
2,546

 
1,190

 
6,449

 
3,575

FDIC assessment
 
1,077

 
1,123

 
3,156

 
2,718

Advertising and public relations
 
380

 
229

 
994

 
775

Communications
 
771

 
563

 
2,098

 
1,648

Net other real estate owned expenses (including taxes)
 
61

 
145

 
223

 
180

Other real estate impairment
 
917

 
51

 
1,037

 
106

Core deposit intangible amortization
 
1,409

 
492

 
3,311

 
1,472

Professional fees
 
1,273

 
717

 
3,212

 
2,354

Acquisition expense, including legal
 
2,428

 
3

 
8,247

 
732

Other
 
4,978

 
3,033

 
12,524

 
9,106

Total noninterest expense
 
47,904

 
26,887

 
127,260

 
86,429

Income before taxes
 
35,210

 
21,659

 
84,304

 
57,939

Income tax expense
 
11,696

 
7,155

 
26,985

 
19,174

Net income
 
$
23,514

 
$
14,504

 
$
57,319

 
$
38,765

Basic earnings per share
 
$
0.85

 
$
0.78

 
$
2.31

 
$
2.10

Diluted earnings per share
 
$
0.84

 
$
0.78

 
$
2.30

 
$
2.09


See Notes to Consolidated Financial Statements




2





Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income
Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands)
   
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
   
 
2017
 
2016
 
2017
 
2016
Net income
 
$
23,514

 
$
14,504

 
$
57,319

 
$
38,765

Other comprehensive income (loss) before tax:
 
   
 
 
 
 
 
 
Change in net unrealized gains (losses) on available for sale securities during the year
 
(219
)
 
(736
)
 
7,095

 
1,876

Reclassification adjustment for gain on sale of securities available for sale included in net income
 

 

 
(52
)
 
(4
)
Other comprehensive income (loss) before tax
 
(219
)
 
(736
)
 
7,043

 
1,872

Income tax expense (benefit)
 
(77
)
 
(258
)
 
2,465

 
655

Other comprehensive income (loss), net of tax
 
(142
)
 
(478
)
 
4,578

 
1,217

Comprehensive income
 
$
23,372

 
$
14,026

 
$
61,897

 
$
39,982


See Notes to Consolidated Financial Statements
   

3





Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity
Nine Months Ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands, except for par value, share and per share information)   
   
Preferred Stock
$.01 Par Value
10 million shares authorized
 
Common Stock
$.01 Par Value
100 million shares authorized
 
Additional
Paid in Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
 (Loss)
Income
 
Total
   
 
Shares
 
Amount
 
Balance, December 31, 2016
$

 
18,870,312

 
$
189

 
$
555,325

 
$
117,951

 
$
(1,100
)
 
$
672,365

Net income

 

 

 

 
57,319

 

 
57,319

Other comprehensive income, net of tax

 

 

 

 

 
4,578

 
4,578

Stock issued for acquisition of bank, net of offering costs of $942

 
8,804,699

 
88

 
551,063

 

 

 
551,151

Restricted stock forfeited

 
(67
)
 

 

 

 

 

Restricted stock granted

 
126,730

 
1

 
(1
)
 

 

 

Stock based compensation expense

 

 

 
3,442

 

 

 
3,442

Exercise of warrants

 
3,203

 

 
55

 

 

 
55

Cash dividends ($0.30 per share)

 

 

 

 
(7,450
)
 

 
(7,450
)
Balance, September 30, 2017
$

 
27,804,877

 
$
278

 
$
1,109,884

 
$
167,820

 
$
3,478

 
$
1,281,460

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2015
$

 
18,399,194

 
$
184

 
$
530,107

 
$
70,698

 
$
2,382

 
$
603,371

Net income

 

 

 

 
38,765

 

 
38,765

Other comprehensive income, net of tax

 

 

 

 

 
1,217

 
1,217

Restricted stock forfeited

 
(6,036
)
 

 

 

 

 

Restricted stock granted

 
95,470

 
1

 
(1
)
 

 

 

Income tax deficiency on restricted stock vested

 

 

 
(193
)
 

 

 
(193
)
Stock based compensation expense

 

 

 
4,533

 

 

 
4,533

Preferred stock dividends

 

 

 

 
(8
)
 

 
(8
)
Cash dividends ($0.24 per share)

 

 

 

 
(4,432
)
 

 
(4,432
)
Balance, September 30, 2016
$

 
18,488,628

 
$
185

 
$
534,446

 
$
105,023

 
$
3,599

 
$
643,253

   
See Notes to Consolidated Financial Statements 

4





Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands) 
   
 
Nine Months Ended September 30,
   
 
2017
 
2016
Cash flows from operating activities:
 
   
 
   
Net income
 
$
57,319

 
$
38,765

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation expense
 
6,203

 
5,027

Accretion income recognized on acquired loans
 
(4,293
)
 
(4,218
)
Amortization of core deposit intangibles
 
3,311

 
1,472

Amortization of premium on securities, net
 
2,633

 
1,528

Amortization of discount and origination costs on borrowings
 
366

 
151

Stock based compensation expense
 
3,442

 
4,533

Excess tax benefit on restricted stock vested
 
(1,272
)
 

FHLB stock dividends
 
(308
)
 
(176
)
Gain on sale of securities available for sale
 
(52
)
 
(4
)
Loss (gain) on sale of premises and equipment
 
15

 
(32
)
Gain on sale of loans
 
(351
)
 

Loss on sale of branch
 
127

 
43

Loss (gain) on sale of other real estate
 
36

 
(57
)
Impairment of other real estate
 
1,037

 
106

Deferred tax expense (benefit)
 
3,329

 
(151
)
Provision for loan losses
 
6,368

 
7,243

Increase in cash surrender value of life insurance
 
(1,959
)
 
(937
)
Originations of loans held for sale
 
(291,330
)
 
(206,567
)
Proceeds from sale of loans held for sale
 
288,053

 
211,769

Net change in other assets
 
(2,537
)
 
1,161

Net change in other liabilities
 
103

 
1,163

Net cash provided by operating activities
 
70,240

 
60,819

Cash flows from investing activities:
 
   
 
   
Proceeds from maturities, calls and pay downs of securities available for sale
 
1,390,770

 
1,107,530

Proceeds from sale of securities available for sale
 
17,227

 
5,399

Purchases of securities available for sale
 
(1,497,707
)
 
(1,106,978
)
Purchases of certificates held in other banks
 
(1,960
)
 

Maturities of certificates held in other banks
 

 
61,746

Proceeds from sale of loans
 
3,867

 

Purchase of bank owned life insurance contracts
 

 
(15,000
)
Net redemptions (purchases) of FHLB stock
 
8,908

 
(12,020
)
Net loans originated - held for investment
 
(386,896
)
 
(372,524
)
Net purchases of mortgage warehouse purchase loans
 
(38,239
)
 

Additions to premises and equipment
 
(11,626
)
 
(4,680
)
Proceeds from sale of premises and equipment
 
15

 
579

Proceeds from sale of other real estate owned
 
5,648

 
1,860

Capitalized additions to other real estate owned
 
(1,032
)
 

Cash received from acquired banks
 
148,444

 

Cash paid in connection with acquisitions
 
(17,773
)
 

Selling costs paid in connection with branch sale
 
(62
)
 
(107
)
Net cash transferred in branch sale
 
(11,765
)
 
(2,399
)
Net cash used in investing activities
 
(392,181
)
 
(336,594
)
Cash flows from financing activities:
 
   
 
   
Net increase in demand deposits, NOW and savings accounts
 
635,877

 
336,624

Net increase (decrease) in time deposits
 
(144,785
)
 
35,530

Proceeds from FHLB advances
 
100,000

 
575,000

Repayments of FHLB advances
 
(59
)
 
(392,560
)
Net change in repurchase agreements
 
(2,765
)
 
8,528

Repayments of other borrowings
 

 
(5,798
)
Proceeds from other borrowings
 

 
43,150

Proceeds from exercise of common stock warrants
 
55

 

Redemption of preferred stock
 

 
(23,938
)
Offering costs paid in connection with acquired banks
 
(942
)
 

Dividends paid
 
(7,450
)
 
(4,440
)
Net cash provided by financing activities
 
579,931

 
572,096

Net change in cash and cash equivalents
 
257,990

 
296,321

Cash and cash equivalents at beginning of year
 
505,027

 
293,279

Cash and cash equivalents at end of period
 
$
763,017

 
$
589,600

See Notes to Consolidated Financial Statements 

5





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)


Note 1. Summary of Significant Accounting Policies
Nature of Operations: Independent Bank Group, Inc. (IBG) through its subsidiary, Independent Bank, a Texas state banking corporation (Bank) (collectively known as the Company), provides a full range of banking services to individual and corporate customers in the North, Central and Houston, Texas areas and along the Colorado Front Range, through its various branch locations in those areas. The Company is engaged in traditional community banking activities, which include commercial and retail lending, deposit gathering, investment and liquidity management activities. The Company’s primary deposit products are demand deposits, money market accounts and certificates of deposit, and its primary lending products are commercial business and real estate, real estate mortgage and consumer loans.
Basis of Presentation: The accompanying consolidated financial statements include the accounts of IBG, its wholly-owned subsidiaries, the Bank, IBG Adriatica Holdings, Inc. (Adriatica) and Carlile Capital, LLC and the Bank’s wholly-owned subsidiaries, IBG Real Estate Holdings, Inc., IBG Real Estate Holdings II, Inc., IBG Aircraft Company III, Preston Grand, Inc., Goldome Financial, LLC, CFRH II, LLC, McKinney Avenue Holdings, Inc. and its wholly owned subsidiary, McKinney Avenue SPE 1, Inc.. Adriatica, McKinney Avenue Holdings, Inc. and its subsidiary are currently not active entities. During the quarter ended September 30, 2017, IBG Real Estate Holdings II, Inc. was formed to hold the real property for the new corporate headquarters.
On April 1, 2017, the Company acquired Carlile Bancshares, Inc. (Carlile) and its wholly owned subsidiaries, Carlile Capital, LLC and Northstar Bank of Texas (Northstar) and its wholly owned subsidiaries, Goldome Financial, LLC and CFRH II, LLC. Carlile has been merged into the Company and dissolved and Northstar has been merged with the Bank as of acquisition date. Carlile Capital and CFRH II, LLC were formed to hold and manage non-performing assets, including loans and other real estate owned and Goldome Financial is a mortgage warehouse purchase company. See Note 10, Business Combination for more details of the Carlile acquisition.
All material intercompany transactions and balances have been eliminated in consolidation. In addition, the Company wholly-owns IB Trust I (Trust I), IB Trust II (Trust II), IB Trust III (Trust III), IB Centex Trust I (Centex Trust I), Community Group Statutory Trust I (CGI Trust I), Northstar Statutory Trust II (Northstar Trust II) and Northstar Statutory Trust III (Northstar Trust III). Northstar Trust II and Northstar Trust III were acquired in the acquisition of Carlile Bancshares. The Trusts were formed to issue trust preferred securities and do not meet the criteria for consolidation.
The consolidated interim financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented. All such adjustments were of a normal and recurring nature. These financial statements should be read in conjunction with the financial statements and the notes thereto in the Company's Annual Report of Form10-K for the year ended December 31, 2016. The consolidated statement of condition at December 31, 2016 had been derived from the audited financial statements as of that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.
Segment Reporting: The Company has one reportable segment. The Company’s chief operating decision-maker uses consolidated results to make operating and strategic decisions.

New Accounting Pronouncement: ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting was effective for the Company on January 1, 2017. ASU 2016-09 requires that all income tax effects related to vestings of share-based payment awards be reported in earnings as an increase (or decrease) to income tax expense. Previously, excess income tax benefits of a vested award were reported as an increase (or decrease) to additional paid-in capital to the extent that those benefits were greater than (or less than) the income tax benefits recognized in earnings during the award's vesting period. The requirement to report those income tax effects in earnings has been applied to vestings occurring on or after January 1, 2017 and resulted in recording a $1,272 tax benefit for the nine months ended September 30, 2017. ASU 2016-09 also requires that all income tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows. We have elected to apply that change in cash flow classification on a prospective basis. The impact of this change and that of the remaining provisions of ASU 2016-09 did not have significant impact on our financial statements.

6





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Subsequent events: Companies are required to evaluate events and transactions that occur after the balance sheet date but before the date the financial statements are issued. They must recognize in the financial statements the effect of all events or transactions that provide additional evidence of conditions that existed at the balance sheet date, including the estimates inherent in the financial statement preparation process. Entities shall not recognize the impact of events or transactions that provide evidence about conditions that did not exist at the balance sheet date but arose after that date. The Company has evaluated subsequent events through the date of filing these financial statements with the Securities and Exchange Commission (SEC) and noted no subsequent events requiring financial statement recognition or disclosure, except as disclosed in Note 11.
Earnings per share: Basic earnings per common share are net income available to common shareholders divided by the weighted average number of common shares outstanding during the period. The unvested share-based payment awards that contain rights to non forfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock warrants. The participating nonvested common stock was not included in dilutive shares as it was anti-dilutive for the three and nine months ended September 30, 2017 and 2016. Proceeds from the assumed exercise of dilutive stock warrants are assumed to be used to repurchase common stock at the average market price.
The following table presents a reconciliation of net income available to common shareholders and the number of shares used in the calculation of basic and diluted earnings per common share.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
   
2017
 
2016
 
2017
 
2016
Basic earnings per share:
   
 
   
 
 
 
 
Net income
$
23,514

 
$
14,504

 
$
57,319

 
$
38,765

Less: Preferred stock dividends

 

 

 
8

Net income after preferred stock dividends
23,514

 
14,504

 
57,319

 
38,757

Less:
 
 
 
 
 
 
 
Undistributed earnings allocated to participating securities
181

 
204

 
555

 
593

Dividends paid on participating securities
24

 
23

 
83

 
76

Net income available to common shareholders
$
23,309

 
$
14,277

 
$
56,681

 
$
38,088

Weighted-average basic shares outstanding
27,555,978

 
18,189,163

 
24,585,473

 
18,145,604

Basic earnings per share
$
0.85

 
$
0.78

 
$
2.31

 
$
2.10

Diluted earnings per share:
   
 
   
 
 
 
 
Net income available to common shareholders
$
23,309

 
$
14,277

 
$
56,681

 
$
38,088

Total weighted-average basic shares outstanding
27,555,978

 
18,189,163

 
24,585,473

 
18,145,604

Add dilutive stock warrants
103,800

 
90,333

 
105,317

 
78,659

Total weighted-average diluted shares outstanding
27,659,778

 
18,279,496

 
24,690,790

 
18,224,263

Diluted earnings per share
$
0.84

 
$
0.78

 
$
2.30

 
$
2.09

Anti-dilutive participating securities
77,498

 
106,355

 
145,925

 
69,460

 

7





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 2. Statement of Cash Flows
As allowed by the accounting standards, the Company has chosen to report on a net basis its cash receipts and cash payments for time deposits accepted and repayments of those deposits, and loans made to customers and principal collections on those loans. The Company uses the indirect method to present cash flows from operating activities. Other supplemental cash flow information is presented below:   
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Cash transactions:
 
 
 
 
Interest expense paid
 
$
31,113

 
$
19,381

Income taxes paid
 
$
21,911

 
$
19,560

Noncash transactions:
 
 
 
 
Transfers of loans to other real estate owned
 
$
750

 
$
1,824

Loans to facilitate the sale of other real estate owned
 
$
684

 
$

Excess tax deficiency on restricted stock vested
 
$

 
$
(193
)
Transfer of bank premises to other real estate
 
$
2,716

 
$

Transfer of repurchase agreements to deposits
 
$

 
$
20,688

  
Supplemental schedule of noncash investing activities from branch sales is as follows:

 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Noncash assets transferred:
 
 
 
 
Loans
 
$
5,439

 
$
2

Premises and equipment
 

 
2,193

Total assets
 
$
5,439

 
$
2,195

Noncash liabilities transferred:
 
 
 
 
Deposits
 
$
17,509

 
$
4,628

Other liabilities
 
28

 
30

Total liabilities
 
$
17,537

 
$
4,658

Cash and cash equivalents transferred in branch sale
 
$
101

 
$
208

Deposit premium received
 
$
333

 
$
64

Cash paid to buyer, net of deposit premium
 
$
11,664

 
$
2,191

















8





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Supplemental schedule of noncash investing activities from acquisitions is as follows:
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Noncash assets acquired
 
 
 
 
Certificates of deposit held in other banks
 
$
11,025

 
$

Securities available for sale
 
336,540

 

Restricted stock
 
11,110

 

Loans
 
1,384,210

 

Premises and equipment
 
63,166

 

Other real estate owned
 
11,124

 

Goodwill
 
348,382

 

Core deposit intangibles
 
36,717

 

Bank owned life insurance
 
53,213

 

Other assets
 
25,197

 

Total assets
 
$
2,280,684

 
$

Noncash liabilities assumed:
 
 
 
 
Deposits
 
$
1,821,938

 
$

Repurchase agreements
 
18,003

 

Junior subordinated debt
 
9,359

 

Other liabilities
 
9,962

 

Total liabilities
 
$
1,859,262

 
$

Cash and cash equivalents acquired from acquisitions
 
$
148,444

 
$

Cash paid to shareholders of acquired banks
 
$
17,773

 
$

Fair value of common stock issued to shareholders of acquired bank
 
$
552,093

 
$


In addition, the following measurement-period adjustments were made during the period related to the acquisition of Grand Bank in 2015:
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Assets acquired:
 
 
 
 
Loans
 
$

 
$
735

Goodwill
 

 
(324
)
Core deposit intangibles
 

 
(216
)
Deferred tax asset
 

 
(175
)
Total assets
 
$

 
$
20

Liabilities assumed:
 
 
 
 
Other liabilities
 

 
20

Total liabilities
 
$

 
$
20








9





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 3. Securities Available for Sale
Securities available for sale have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their approximate fair values at September 30, 2017 and December 31, 2016, are as follows:   
   
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Securities Available for Sale
 
   
 
   
 
   
 
   
September 30, 2017
 
   
 
   
 
   
 
   
U. S. treasuries
 
$
32,383

 
$
1

 
$
(62
)
 
$
32,322

Government agency securities
 
231,876

 
194

 
(876
)
 
231,194

Obligations of state and municipal subdivisions
 
227,116

 
2,874

 
(777
)
 
229,213

Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
240,992

 
3,245

 
(181
)
 
244,056

Other securities
 
10,342

 
20

 

 
10,362

   
 
$
742,709

 
$
6,334

 
$
(1,896
)
 
$
747,147

December 31, 2016
 
   
 
   
 
   
 
   
U.S. treasuries
 
$
3,208

 
$

 
$
(61
)
 
$
3,147

Government agency securities
 
123,605

 
141

 
(1,479
)
 
122,267

Obligations of state and municipal subdivisions
 
88,358

 
920

 
(2,022
)
 
87,256

Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
103,869

 
928

 
(1,032
)
 
103,765

   
 
$
319,040

 
$
1,989

 
$
(4,594
)
 
$
316,435

Securities with a carrying amount of approximately $264,852 and $176,457 at September 30, 2017 and December 31, 2016, respectively, were pledged to secure public fund deposits and repurchase agreements.
Proceeds from sale of securities available for sale and gross gains and gross losses for the three and nine months ended September 30, 2017 and 2016 were as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Proceeds from sale
 
417

 
$

 
$
17,227

 
$
5,399

Gross gains
 

 

 
104

 
4

Gross losses
 

 

 
52

 








10





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The amortized cost and estimated fair value of securities available for sale at September 30, 2017, by contractual maturity, are shown below. Maturities of pass-through certificates will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.   
 
 
September 30, 2017
 
 
Securities Available for Sale
 
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
95,050

 
$
95,006

Due from one year to five years
 
213,146

 
213,082

Due from five to ten years
 
93,551

 
93,976

Thereafter
 
99,970

 
101,027

 
 
501,717

 
503,091

Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
240,992

 
244,056

 
 
$
742,709

 
$
747,147


The number of securities, unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of September 30, 2017 and December 31, 2016, are summarized as follows:   
   
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
Description of Securities
 
Number of Securities
 
Estimated
Fair Value
 
Unrealized
Losses
 
Number of Securities
 
Estimated
Fair Value
 
Unrealized
Losses
 
Estimated
Fair Value
 
Unrealized
Losses
Securities Available for Sale
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
September 30, 2017
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
U.S. treasuries
 
6
 
$
30,320

 
$
(62
)
 
 
$

 
$

 
$
30,320

 
$
(62
)
Government agency securities
 
48
 
131,393

 
(458
)
 
21
 
45,680

 
(418
)
 
177,073

 
(876
)
Obligations of state and municipal subdivisions
 
100
 
42,864

 
(184
)
 
46
 
23,618

 
(593
)
 
66,482

 
(777
)
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
13
 
33,003

 
(181
)
 
 

 

 
33,003

 
(181
)
   
 
167
 
$
237,580

 
$
(885
)
 
67
 
$
69,298

 
$
(1,011
)
 
$
306,878

 
$
(1,896
)
December 31, 2016
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
U.S. treasuries
 
1
 
$
3,147

 
$
(61
)
 
 
$

 
$

 
$
3,147

 
$
(61
)
Government agency securities
 
43
 
102,044

 
(1,472
)
 
1
 
993

 
(7
)
 
103,037

 
(1,479
)
Obligations of state and municipal subdivisions
 
100
 
46,186

 
(2,011
)
 
4
 
1,549

 
(11
)
 
47,735

 
(2,022
)
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
30
 
67,868

 
(1,032
)
 
 

 

 
67,868

 
(1,032
)
   
 
174
 
$
219,245

 
$
(4,576
)
 
5
 
$
2,542

 
$
(18
)
 
$
221,787

 
$
(4,594
)
Unrealized losses are generally due to changes in interest rates. The Company has the intent to hold these securities until maturity or a forecasted recovery, and it is more likely than not that the Company will not have to sell the securities before the recovery of their cost basis. As such, the losses are deemed to be temporary.   




11





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 4. Loans, Net and Allowance for Loan Losses
Loans, net, at September 30, 2017 and December 31, 2016, consisted of the following:
   
 
 
September 30,
 
December 31,
   
 
2017
 
2016
Commercial
 
$
1,006,104

 
$
630,805

Real estate:
 
   
 
   
Commercial
 
3,255,053

 
2,459,221

Commercial construction, land and land development
 
710,475

 
531,481

Residential
 
877,920

 
634,545

Single family interim construction
 
319,093

 
235,475

Agricultural
 
156,824

 
53,548

Consumer
 
39,098

 
27,530

Other
 
337

 
166

   
 
6,364,904

 
4,572,771

Deferred loan fees
 
(2,589
)
 
(2,117
)
Allowance for loan losses
 
(37,770
)
 
(31,591
)
   
 
$
6,324,545

 
$
4,539,063


The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans.
Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. The Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. These cash flows, however, may not be as expected and the value of collateral securing the loans may fluctuate. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short term loans may be made on an unsecured basis. Our commercial loan portfolio also includes loans made to customers in the energy industry, which is a complex, technical and cyclical industry. Experienced bankers with specialized energy lending experience originate our energy loans. Companies in this industry produce, extract, develop, exploit and explore for oil and natural gas. Loans are primarily collateralized with proven producing oil and gas reserves based on a technical evaluation of these reserves. At September 30, 2017 and December 31, 2016, there were approximately $87,832 and $115,311 of exploration and production (E&P) energy loans outstanding, respectively. Additionally, with the acquisition of Carlile, the Company acquired a mortgage warehouse purchase company, Goldome Financial, which provides mortgage warehouse lending vehicle to mortgage bankers across a broad geographic scale. The mortgage loans are underwritten, in part, on approved investor takeout commitments. These loans have a very short duration ranging between 10 days and 15 days. In some cases, loans to larger mortgage originators may be financed for up to 60 days. These loans are reported as business loans since the loans are secured by notes receivable, not real estate. As of September 30, 2017, mortgage warehouse purchase loans outstanding totaled $138,561.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally largely dependent on the successful operation of the property or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors the diversification of the portfolio on a quarterly basis by type and geographic location. Management also tracks the level of owner occupied property versus non owner occupied property.

12





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Land and commercial land development loans are underwritten using feasibility studies, independent appraisal reviews and financial analysis of the developers or property owners. Generally, borrowers must have a proven track record of success. Commercial construction loans are generally based upon estimates of cost and value of the completed project. These estimates may not be accurate. Commercial construction loans often involve the disbursement of substantial funds with the repayment dependent on the success of the ultimate project. Sources of repayment for these loans may be pre-committed permanent financing or sale of the developed property. The loans in this portfolio are geographically diverse and due to the increased risk are monitored closely by management and the board of directors on a quarterly basis.
Residential real estate and single family interim construction loans are underwritten primarily based on borrowers’ credit scores, documented income and minimum collateral values. Relatively small loan amounts are spread across many individual borrowers, which minimizes risk in the residential portfolio. In addition, management evaluates trends in past dues and current economic factors on a regular basis.
Agricultural loans are collateralized by real estate and/or agricultural-related assets. Agricultural real estate loans are primarily comprised of loans for the purchase of farmland. Loan-to-value ratios on loans secured by farmland generally do not exceed 80% and have amortization periods limited to twenty years. Agricultural non-real estate loans are generally comprised of term loans to fund the purchase of equipment, livestock and seasonal operating lines to grain farmers to plant and harvest corn and soybeans. Specific underwriting standards have been established for agricultural-related loans, including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary.
Agricultural loans carry significant credit risks as they involve larger balances concentrated with single borrowers or groups of related borrowers. In addition, repayment of such loans depends on the successful operation or management of the farm property securing the loan or for which an operating loan is utilized. Farming operations may be affected by adverse weather conditions such as drought, hail or floods that can severely limit crop yields.
Consumer loans represent less than 1% of the outstanding total loan portfolio. Collateral consists primarily of automobiles and other personal assets. Credit score analysis is used to supplement the underwriting process.
Most of the Company’s lending activity occurs within the State of Texas, primarily in the north, central and southeast Texas regions. With the acquisition of Carlile as further explained in Note 10, Business Combination, the Company expanded into the State of Colorado, specifically along the Front Range area. As of September 30, 2017, loans in the Colorado region represented about 7% of the total portfolio. A large percentage of the Company’s portfolio consists of commercial and residential real estate loans. As of September 30, 2017 and December 31, 2016, there were no concentrations of loans related to a single industry in excess of 10% of total loans.
The allowance for loan losses is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio.
The allowance is derived from the following two components: 1) allowances established on individual impaired loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates, and 2) allowances based on actual historical loss experience for the last three years for similar types of loans in the Company’s loan portfolio adjusted for primarily changes in the lending policies and procedures; collection, charge-off and recovery practices; nature and volume of the loan portfolio; change in value of underlying collateral; volume and severity of nonperforming loans; existence and effect of any concentrations of credit and the level of such concentrations and current, national and local economic and business conditions. This second component also includes an unallocated allowance to cover uncertainties that could affect management’s estimate of probable losses. The unallocated allowance reflects the imprecision inherent in the underlying assumptions used in the methodologies for estimating this component.
The Company’s management continually evaluates the allowance for loan losses determined from the allowances established on individual loans and the amounts determined from historical loss percentages adjusted for the qualitative factors above. Should any of the factors considered by management change, the Company’s estimate of loan losses could also change and would

13





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

affect the level of future provision expense. While the calculation of the allowance for loan losses utilizes management’s best judgment and all the information available, the adequacy of the allowance for loan losses is dependent on a variety of factors beyond the Company’s control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications.
In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses, and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations.
Loans requiring an allocated loan loss provision are generally identified at the servicing officer level based on review of weekly past due reports and/or the loan officer’s communication with borrowers. In addition, past due loans are discussed at weekly officer loan committee meetings to determine if classification is warranted. The Company’s credit department has implemented an internal risk based loan review process to identity potential internally classified loans that supplements the annual independent external loan review. The external review generally covers all loans greater than $3.25 million annually. These reviews include analysis of borrower’s financial condition, payment histories and collateral values to determine if a loan should be internally classified. Generally, once classified, an impaired loan analysis is completed by the credit department to determine if the loan is impaired and the amount of allocated allowance required.
The Texas and Colorado economies, specifically the Company’s lending area of north, central and southeast Texas and the Colorado Front Range area, have continued to expand and recover at a moderate pace during 2017 due largely to improvement in manufacturing output, the energy sector and a strong labor force. The Texas economy is the second largest in the nation. However, uncertainty exists in the potential effect of the Trump administration's impact on foreign trade policy, specifically related to the service and manufacturing industries and industrial real estate. The risk of loss associated with all segments of the portfolio could increase due to this impact. In addition, during third quarter 2017, the Texas economy was somewhat impacted by Hurricane Harvey ("Harvey"), which preliminary estimates indicate could be one of the costliest U.S. natural catastrophes. The Bank initiated a Disaster Recovery Policy as a result of Harvey putting in place procedures and approval authorities for credit officers to provide relief for impacted borrowers. In the overall analysis of Harvey's potential impact on the Bank's loan portfolio, management believes that no significant additional risk has materialized. The Houston portfolio, which is mostly real estate, totals $1.4 billion and lenders have confirmed modest amounts of damage. Management believes no additional reserves are warranted at this time as a result of Harvey. The overall economic impact will be more evident as additional third quarter data is collected. However, the storm's negative impact on employment and business activity is expected to be transitory and should not derail the state's positive economic momentum, according to the Dallas Fed economists.

14





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The economy and other risk factors are minimized by the Company’s underwriting standards, which include the following principles: 1) financial strength of the borrower including strong earnings, high net worth, significant liquidity and acceptable debt to worth ratio, 2) managerial business competence, 3) ability to repay, 4) loan to value, 5) projected cash flow and 6) guarantor financial statements as applicable. The following is a summary of the activity in the allowance for loan losses by loan class for the three and nine months ended September 30, 2017 and 2016:
 
Commercial
Commercial
Real Estate,
Land and Land
Development
Residential
Real Estate
Single-Family
Interim
Construction
Agricultural
Consumer
Other
Unallocated
Total
Three months ended September 30, 2017
 
 

 

 

 
Balance at the beginning of period
$
8,700

$
21,497

$
3,292

$
1,387

$
272

$
288

$
12

$
433

$
35,881

Provision for loan losses
533

949

33

258

8

(37
)
22

107

1,873

Charge-offs





(1
)
(38
)

(39
)
Recoveries
3

3

1



29

19


55

Balance at end of period
$
9,236

$
22,449

$
3,326

$
1,645

$
280

$
279

$
15

$
540

$
37,770

 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2017
 
 
 
 
 
 
 
 
Balance at the beginning of period
$
8,593

$
18,399

$
2,760

$
1,301

$
207

$
242

$
29

$
60

$
31,591

Provision for loan losses
618

4,026

563

478

73

62

68

480

6,368

Charge-offs



(134
)

(68
)
(115
)

(317
)
Recoveries
25

24

3



43

33


128

Balance at end of period
$
9,236

$
22,449

$
3,326

$
1,645

$
280

$
279

$
15

$
540

$
37,770

 
 
 
 
 
 
 
 
 
 
Three months ended September 30, 2016
 
 
 
 
 
 
 
 
Balance at the beginning of period
$
11,357

$
15,492

$
2,533

$
1,121

$
175

$
171

$
28

$
39

$
30,916

Provision for loan losses
412

1,021

601

113

13

(6
)
23

(54
)
2,123

Charge-offs
(3,025
)

(421
)


(5
)
(33
)

(3,484
)
Recoveries
3

4

2



2

9


20

Balance at end of period
$
8,747

$
16,517

$
2,715

$
1,234

$
188

$
162

$
27

$
(15
)
$
29,575

 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2016
 
 
 
 
 
 
 
 
Balance at the beginning of period
$
10,573

$
13,007

$
2,339

$
769

$
215

$
164

$

$
(24
)
$
27,043

Provision for loan losses
2,378

3,558

786

465

(27
)
(2
)
76

9

7,243

Charge-offs
(4,216
)
(54
)
(421
)


(7
)
(78
)

(4,776
)
Recoveries
12

6

11



7

29


65

Balance at end of period
$
8,747

$
16,517

$
2,715

$
1,234

$
188

$
162

$
27

$
(15
)
$
29,575


15





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The following table details the amount of the allowance for loan losses and recorded investment in loans by class as of September 30, 2017 and December 31, 2016:
 
Commercial
Commercial
Real Estate,
Land and Land
Development
Residential
Real Estate
Single-Family
Interim
Construction
Agricultural
Consumer
Other
Unallocated
Total
September 30, 2017
 
 
 
 
 
 
 
 
 
Allowance for losses:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,530

$

$

$

$

$
94

$

$

$
2,624

Collectively evaluated for impairment
6,706

22,449

3,326

1,645

280

185

15

540

35,146

Loans acquired with deteriorated credit quality









Ending balance
$
9,236

$
22,449

$
3,326

$
1,645

$
280

$
279

$
15

$
540

$
37,770

 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
8,226

$
2,711

$
3,226

$

$

$
237

$

$

$
14,400

Collectively evaluated for impairment
983,119

3,888,539

870,784

314,914

152,457

38,836

337


6,248,986

Acquired with deteriorated credit quality
14,759

74,278

3,910

4,179

4,367

25



101,518

Ending balance
$
1,006,104

$
3,965,528

$
877,920

$
319,093

$
156,824

$
39,098

$
337

$

$
6,364,904

 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
Allowance for losses:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
3

$
4

$

$
84

$

$
94

$

$

$
185

Collectively evaluated for impairment
8,590

18,395

2,760

1,217

207

148

29

60

31,406

Loans acquired with deteriorated credit quality









Ending balance
$
8,593

$
18,399

$
2,760

$
1,301

$
207

$
242

$
29

$
60

$
31,591

 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
7,720

$
7,089

$
1,889

$
884

$

$
279

$

$

$
17,861

Collectively evaluated for impairment
620,665

2,953,333

630,689

234,591

53,548

27,240

166


4,520,232

Acquired with deteriorated credit quality
2,420

30,280

1,967



11



34,678

Ending balance
$
630,805

$
2,990,702

$
634,545

$
235,475

$
53,548

$
27,530

$
166

$

$
4,572,771












16





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Nonperforming loans by loan class (excluding loans acquired with deteriorated credit quality) at September 30, 2017 and December 31, 2016, are summarized as follows:
   
 
 
Commercial
 
Commercial
Real Estate,
Land and Land
Development
 
Residential Real Estate
 
Single-Family
Interim
Construction
 
Agricultural
 
Consumer
 
Other
 
Total
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonaccrual loans
 
$
8,254

 
$
1,744

 
$
2,389

 
$

 
$

 
$
237

 
$

 
$
12,624

Loans past due 90 days and still accruing
 
16

 

 
16

 

 
9

 
2

 

 
43

Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)
 

 
1,067

 
919

 

 

 

 

 
1,986

 
 
$
8,270

 
$
2,811

 
$
3,324

 
$

 
$
9

 
$
239

 
$

 
$
14,653

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonaccrual loans
 
$
7,718

 
$
5,885

 
$
866

 
$
884

 
$

 
$
273

 
$

 
$
15,626

Loans past due 90 days and still accruing
 

 

 

 

 

 

 

 

Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)
 
1

 
1,204

 
1,011

 

 

 

 

 
2,216

 
 
$
7,719

 
$
7,089

 
$
1,877

 
$
884

 
$

 
$
273

 
$

 
$
17,842

The accrual of interest is discontinued on a loan when management believes after considering collection efforts and other factors that the borrower's financial condition is such that collection of interest is doubtful. All interest accrued but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income. Cash collections on nonaccrual loans are generally credited to the loan receivable balance, and no interest income is recognized on those loans until the principal balance has been collected. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Impaired loans are those loans where it is probable that all amounts due will not be collected according to contractual terms of the loan agreement. The Company has identified these loans through its normal loan review procedures. Impaired loans are measured based on 1) the present value of expected future cash flows discounted at the loans effective interest rate; 2) the loan's observable market price; or 3) the fair value of collateral if the loan is collateral dependent. Substantially all of the Company’s impaired loans are measured at the fair value of the collateral. In limited cases, the Company may use the other methods to determine the level of impairment of a loan if such loan is not collateral dependent.
All commercial, real estate, agricultural loans and troubled debt restructurings are considered for individual impairment analysis. Smaller balance consumer loans are collectively evaluated for impairment.

17





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Impaired loans by loan class (excluding loans acquired with deteriorated credit quality) at September 30, 2017 and December 31, 2016, are summarized as follows:
   
 
 
Commercial
 
Commercial
Real Estate,
Land and Land
Development
 
Residential
Real Estate
 
Single-Family
Interim
Construction
 
Agricultural
 
Consumer
 
Other
 
Total
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment in impaired loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans with an allowance for loan losses
 
$
6,561

 
$

 
$

 
$

 
$

 
$
202

 
$

 
$
6,763

Impaired loans with no allowance for loan losses
 
1,665

 
2,711

 
3,226

 

 

 
35

 

 
7,637

Total
 
$
8,226

 
$
2,711

 
$
3,226

 
$

 
$

 
$
237

 
$

 
$
14,400

Unpaid principal balance of impaired loans
 
$
11,360

 
$
2,747

 
$
3,295

 
$

 
$

 
$
268

 
$

 
$
17,670

Allowance for loan losses on impaired loans
 
$
2,530

 
$

 
$

 
$

 
$

 
$
94

 
$

 
$
2,624

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment in impaired loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans with an allowance for loan losses
 
$
8

 
$
78

 
$

 
$
168

 
$

 
$
209

 
$

 
$
463

Impaired loans with no allowance for loan losses
 
7,712

 
7,011

 
1,889

 
716

 

 
70

 

 
17,398

Total
 
$
7,720

 
$
7,089

 
$
1,889

 
$
884

 
$

 
$
279

 
$

 
$
17,861

Unpaid principal balance of impaired loans
 
$
10,844

 
$
7,133

 
$
2,087

 
$
884

 
$

 
$
291

 
$

 
$
21,239

Allowance for loan losses on impaired loans
 
$
3

 
$
4

 
$

 
$
84

 
$

 
$
94

 
$

 
$
185

For the three months ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
 
$
8,201

 
$
2,769

 
$
2,847

 
$

 
$

 
$
246

 
$

 
$
14,063

Interest income recognized on impaired loans
 
$

 
$
15

 
$
14

 
$

 
$

 
$

 
$

 
$
29

For the nine months ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
 
$
8,081

 
$
3,849

 
$
2,608

 
$
221

 
$

 
$
254

 
$

 
$
15,013

Interest income recognized on impaired loans
 
$
4

 
$
427

 
$
38

 
$

 
$

 
$
5

 
$

 
$
474

For the three months ended September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
 
$
9,920

 
$
1,338

 
$
2,831

 
$

 
$

 
$
62

 
$

 
$
14,151

Interest income recognized on impaired loans
 
$
57

 
$
18

 
$
12

 
$

 
$

 
$

 
$

 
$
87

For the nine months ended September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
 
$
12,799

 
$
2,383

 
$
2,994

 
$

 
$
43

 
$
78

 
$

 
$
18,297

Interest income recognized on impaired loans
 
$
57

 
$
56

 
$
84

 
$

 
$

 
$

 
$

 
$
197

Certain impaired loans have adequate collateral and do not require a related allowance for loan loss.

18





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The Company will charge off that portion of any loan which management considers a loss. Commercial and real estate loans are generally considered for charge-off when exposure beyond collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition.
The restructuring of a loan is considered a “troubled debt restructuring” if both 1) the borrower is experiencing financial difficulties and 2) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, extending amortization and other actions intended to minimize potential losses.
A “troubled debt restructured” loan is identified as impaired and measured for credit impairment as of each reporting period in accordance with the guidance in  Accounting Standards Codification (ASC) 310-10-35. Modifications primarily relate to extending the amortization periods of the loans and interest rate concessions. The majority of these loans were identified as impaired prior to restructuring; therefore, the modifications did not materially impact the Company’s determination of the allowance for loan losses. The recorded investment in troubled debt restructurings, including those on nonaccrual, was $3,466 and $2,425 as of September 30, 2017 and December 31, 2016.

19





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Following is a summary of loans modified under troubled debt restructurings during the three and nine months ended September 30, 2017 and 2016:
 
 
Commercial
 
Commercial
Real Estate,
Land and Land
Development
 
Residential
Real Estate
 
Single-Family
Interim
Construction
 
Agricultural
 
Consumer
 
Other
 
Total
Troubled debt restructurings during the three months ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of contracts
 
1

 

 

 

 

 

 

 
1

Pre-restructuring outstanding recorded investment
 
$
873

 
$

 
$

 
$

 
$

 
$

 
$

 
$
873

Post-restructuring outstanding recorded investment
 
$
873

 
$

 
$

 
$

 
$

 
$

 
$

 
$
873

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Troubled debt restructurings during the nine months ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of contracts
 
1

 

 
1

 

 

 
1

 

 
3

Pre-restructuring outstanding recorded investment
 
$
873

 
$

 
$
465

 
$

 
$

 
$
22

 
$

 
$
1,360

Post-restructuring outstanding recorded investment
 
$
873

 
$

 
$
465

 
$

 
$

 
$
22

 
$

 
$
1,360

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Troubled debt restructurings during the three months ended September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of contracts
 

 

 

 

 

 

 

 

Pre-restructuring outstanding recorded investment
 
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

Post-restructuring outstanding recorded investment
 
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Troubled debt restructurings during the nine months ended September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of contracts
 
1

 

 

 

 

 

 

 
1

Pre-restructuring outstanding recorded investment
 
$
24

 
$

 
$

 
$

 
$

 
$

 
$

 
$
24

Post-restructuring outstanding recorded investment
 
$
24

 
$

 
$

 
$

 
$

 
$

 
$

 
$
24

At September 30, 2017 and 2016, there were no loans modified under troubled debt restructurings during the previous twelve month period that subsequently defaulted during the three and nine months ended September 30, 2017 and 2016, respectively. At September 30, 2017 and 2016, the Company had no commitments to lend additional funds to any borrowers with loans whose terms have been modified under troubled debt restructurings.



20





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The following table presents information regarding the aging of past due loans by loan class as of September 30, 2017 and December 31, 2016:
   
 
 
Loans
30-89 Days
Past Due
 
Loans
90 or More
Past Due
 
Total Past
Due Loans
 
Current
Loans
 
Total
Loans
September 30, 2017
 
 
 
 
 
 
 
 
 
 
Commercial
 
$
1,714

 
$
8,240

 
$
9,954

 
$
981,391

 
$
991,345

Commercial real estate, land and land  development
 
2,094

 
1,612

 
3,706

 
3,887,544

 
3,891,250

Residential real estate
 
3,419

 
1,455

 
4,874

 
869,136

 
874,010

Single-family interim construction
 

 

 

 
314,914

 
314,914

Agricultural
 
99

 
9

 
108

 
152,349

 
152,457

Consumer
 
177

 
232

 
409

 
38,664

 
39,073

Other
 

 

 

 
337

 
337

 
 
7,503

 
11,548

 
19,051

 
6,244,335

 
6,263,386

Acquired with deteriorated credit quality
 
3,768

 
6,792

 
10,560

 
90,958

 
101,518

 
 
$
11,271

 
$
18,340

 
$
29,611

 
$
6,335,293

 
$
6,364,904

December 31, 2016
 
 
 
 
 
 
 
 
 
 
Commercial
 
$
226

 
$
7,711

 
$
7,937

 
$
620,448

 
$
628,385

Commercial real estate, land and land  development
 
151

 
6,752

 
6,903

 
2,953,519

 
2,960,422

Residential real estate
 
846

 
561

 
1,407

 
631,171

 
632,578

Single-family interim construction
 
1,062

 

 
1,062

 
234,413

 
235,475

Agricultural
 
10

 

 
10

 
53,538

 
53,548

Consumer
 
154

 
52

 
206

 
27,313

 
27,519

Other
 

 

 

 
166

 
166

 
 
2,449

 
15,076

 
17,525

 
4,520,568

 
4,538,093

Acquired with deteriorated credit quality
 
181

 
910

 
1,091

 
33,587

 
34,678

 
 
$
2,630

 
$
15,986

 
$
18,616

 
$
4,554,155

 
$
4,572,771

The Company’s internal classified report is segregated into the following categories: 1) Pass/Watch, 2) Special Mention, 3) Substandard and 4) Doubtful. The loans placed in the Pass/Watch category reflect the Company’s opinion that the loans reflect potential weakness that requires monitoring on a more frequent basis. The loans in the Special Mention category reflect the Company’s opinion that the credit contains weaknesses which represent a greater degree of risk and warrant extra attention. These loans are reviewed monthly by officers and senior management to determine if a change in category is warranted. The loans placed in the Substandard category are considered to be potentially inadequately protected by the current debt service capacity of the borrower and/or the pledged collateral. These credits, even if apparently protected by collateral value, have shown weakness related to adverse financial, managerial, economic, market or political conditions, which may jeopardize repayment of principal and interest. There is possibility that some future loss could be sustained by the Company if such weakness is not corrected. The Doubtful category includes loans that are in default or principal exposure is probable. Substandard and Doubtful loans are individually evaluated to determine if they should be classified as impaired and an allowance is allocated if deemed necessary under ASC 310-10.
The loans that are not impaired are included with the remaining “pass” credits in determining the portion of the allowance for loan loss based on historical loss experience and other qualitative factors. The portfolio is segmented into categories including: commercial loans, consumer loans, commercial real estate loans, residential real estate loans and agricultural loans. The

21





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

adjusted historical loss percentage is applied to each category. Each category is then added together to determine the allowance allocated under ASC 450-20.
A summary of loans by credit quality indicator by class as of September 30, 2017 and December 31, 2016, is as follows:
   
 
 
Pass
 
Pass/
Watch
 
Special Mention
 
Substandard
 
Doubtful
 
Total
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
$
933,126

 
$
39,532

 
$
3,783

 
$
29,663

 
$

 
$
1,006,104

Commercial real estate, construction, land  and land development
 
3,877,125

 
58,568

 
13,924

 
15,911

 

 
3,965,528

Residential real estate
 
867,627

 
3,295

 
1,197

 
5,801

 

 
877,920

Single-family interim construction
 
313,133

 
4,921

 

 
1,039

 

 
319,093

Agricultural
 
127,846

 
9,903

 
14,708

 
4,367

 

 
156,824

Consumer
 
38,799

 
9

 
7

 
283

 

 
39,098

Other
 
337

 

 

 

 

 
337

 
 
$
6,157,993

 
$
116,228

 
$
33,619

 
$
57,064

 
$

 
$
6,364,904

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
$
555,342

 
$
31,954

 
$
16,734

 
$
26,775

 
$

 
$
630,805

Commercial real estate, construction, land  and land development
 
2,972,732

 
5,426

 
5,148

 
7,396

 

 
2,990,702

Residential real estate
 
629,081

 
1,897

 
370

 
3,197

 

 
634,545

Single-family interim construction
 
233,800

 
791

 

 
884

 

 
235,475

Agricultural
 
52,724

 
569

 
255

 

 

 
53,548

Consumer
 
27,215

 
12

 
3

 
300

 

 
27,530

Other
 
166

 

 

 

 

 
166

 
 
$
4,471,060

 
$
40,649

 
$
22,510

 
$
38,552

 
$

 
$
4,572,771

The Company has acquired certain loans which experienced credit deterioration since origination (purchased credit impaired (PCI) loans).
The Company has included PCI loans in the above grading tables. The following provides additional detail on the grades applied to those loans at September 30, 2017 and December 31, 2016:
 
 
Pass
 
Pass/
Watch
 
Special Mention
 
Substandard
 
Doubtful
 
Total
September 30, 2017
 
$
38,752

 
$
37,440

 
$
3,752

 
$
21,574

 
$

 
$
101,518

December 31, 2016
 
30,498

 
1,237

 
1,069

 
1,874

 

 
34,678

PCI loans may remain on accrual status to the extent the company can reasonably estimate the amount and timing of expected future cash flows. At September 30, 2017 and December 31, 2016, non-accrual PCI loans were $10,401 and $960, respectively.

22





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Accretion on PCI loans is based on estimated future cash flows, regardless of contractual maturity. The following table summarizes the outstanding balance and related carrying amount of purchased credit impaired loans as of the respective acquisition date for the acquisition occurring in 2017:
 
 
Acquisition Date
 
 
April 1, 2017
   
 
Carlile Bancshares, Inc.
Outstanding balance
 
$
101,153

Nonaccretable difference
 
(12,630
)
Accretable yield
 
(3,916
)
Carrying amount
 
$
84,607


The carrying amount of all acquired PCI loans included in the consolidated balance sheet and the related outstanding balance at September 30, 2017 and December 31, 2016 were as follows:
 
September 30, 2017
 
December 31, 2016
Outstanding balance
$
117,978

 
$
39,442

Carrying amount
101,518

 
34,678

There was no allocation established in the allowance for loan losses relating to PCI loans at September 30, 2017 or December 31, 2016.

The changes in accretable yield during the nine months ended September 30, 2017 and 2016 in regard to loans transferred at acquisition for which it was probable that all contractually required payments would not be collected are presented in the table below.
 
For the Nine Months Ended September 30,
 
2017
 
2016
Balance at January 1,
$
1,526

 
$
2,380

Additions
3,916

 

Accretion
(3,586
)
 
(759
)
Transfers from nonaccretable

 

Balance at September 30,
$
1,856

 
$
1,621



23





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 5. Commitments and Contingencies

Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. The commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of this instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. At September 30, 2017 and December 31, 2016, the approximate amounts of these financial instruments were as follows:   
   
 
September 30,
 
December 31,
 
 
2017
 
2016
Commitments to extend credit
 
$
1,115,678

 
$
865,668

Standby letters of credit
 
8,580

 
10,562

 
 
$
1,124,258

 
$
876,230

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, farm crops, property, plant and equipment and income-producing commercial properties.
Letters of credit are written conditional commitments used by the Company to guarantee the performance of a customer to a third party. The Company’s policies generally require that letter of credit arrangements contain security and debt covenants similar to those contained in loan arrangements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount shown in the table above. If the commitment is funded, the Company would be entitled to seek recovery from the customer. As of September 30, 2017 and December 31, 2016, no amounts have been recorded as liabilities for the Company’s potential obligations under these guarantees.
 
Litigation  
The Company is involved in certain legal actions arising from normal business activities. Management believes that the outcome of such proceedings will not materially affect the financial position, results of operations or cash flows of the Company.

Independent Bank is a party to a legal proceeding inherited in connection with its acquisition of BOH Holdings, Inc. and its subsidiary, Bank of Houston. Please see Part II, Item 1. for more details on this lawsuit.

Lease Commitments
The Company leases certain branch facilities and other facilities. Rent expense related to these leases amounted to $873 and $2,278 for the three and nine months ended September 30, 2017, respectively, and $516 and $1,575 for the three and nine months ended September 30, 2016, respectively.

   

24





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 6. Income Taxes

Income tax expense for the three and nine months ended September 30, 2017 and 2016 was as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Income tax expense for the period
$
11,696

 
$
7,155

 
$
26,985

 
$
19,174

Effective tax rate
33.2
%
 
33.0
%
 
32.0
%
 
33.1
%

The effective tax rates differ from the statutory federal tax rate of 35% largely due to tax exempt interest income earned on certain investment securities and loans and the nontaxable earnings on bank owned life insurance. In addition, the effective tax rate differs for the three and nine months ended September 30, 2017 due to nondeductible acquisition expenses incurred during the period and excess tax benefit on restricted stock vestings recognized in income tax expense during the period as a result of adopting ASU 2016-09 on January 1, 2017.


Note 7. Fair Value Measurements
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
Level 3 Inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.












25





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The following table represents assets reported on the consolidated balance sheets at their fair value on a recurring basis as of September 30, 2017 and December 31, 2016 by level within the ASC Topic 820 fair value measurement hierarchy:   
 
 
 
 
Fair Value Measurements at Reporting Date Using
 
 
Assets/
Liabilities
Measured at
Fair Value
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
September 30, 2017
 
 
 
 
 
 
 
 
Measured on a recurring basis:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Investment securities available for sale:
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
32,322

 
$

 
$
32,322

 
$

Government agency securities
 
231,194

 

 
231,194

 

Obligations of state and municipal subdivisions
 
229,213

 

 
229,213

 

Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
244,056

 

 
244,056

 

Other securities
 
10,362

 
10,362

 

 

December 31, 2016
 
 
 
 
 
 
 
 
Measured on a recurring basis:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Investment securities available for sale:
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
3,147

 
$

 
$
3,147

 
$

Government agency securities
 
122,267

 

 
122,267

 

Obligations of state and municipal subdivisions
 
87,256

 

 
87,256

 

Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
103,765

 

 
103,765

 

There were no transfers between level categorizations and no changes in valuation methodologies for the periods presented.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Securities classified as available for sale are reported at fair value utilizing Level 1 and Level 2 inputs. Securities are classified within Level 1 when quoted market prices are available in an active market. Inputs include securities that have quoted prices in active markets for identical assets. For securities utilizing Level 2 inputs, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury and other yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things.







26





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

In accordance with ASC Topic 820, certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the assets carried on the consolidated balance sheet by caption and by level in the fair value hierarchy at September 30, 2017 and December 31, 2016, for which a nonrecurring change in fair value has been recorded:   
   
 
   
 
Fair Value Measurements at Reporting Date Using
 
 
   
 
Assets
Measured
at Fair Value
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs (Level 3)
 
Period Ended
Total Losses
September 30, 2017
 
   
 
   
 
   
 
   
 
   
Measured on a nonrecurring basis:
 
   
 
   
 
   
 
   
 
   
Assets:
 
   
 
   
 
   
 
   
 
   
Impaired loans
 
$
4,031

 
$

 
$

 
$
4,031

 
$
2,530

Other real estate
 
322

 

 

 
322

 
120

 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
   

 
   
 
   
 
   
Measured on a nonrecurring basis:
 
 
 
   
 
   
 
   
 
   
Assets:
 
 
 
   
 
   
 
   
 
   
Impaired loans
 
$
968

 
$

 
$

 
$
968

 
$
708

Other real estate
 
340

 

 

 
340

 
52


Impaired loans (loans which are not expected to repay all principal and interest amounts due in accordance with the original contractual terms) are measured at an observable market price (if available) or at the fair value of the loan’s collateral (if collateral dependent). Fair value of the loan’s collateral is determined by appraisals or independent valuation, which is then adjusted for the estimated costs related to liquidation of the collateral. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. Therefore, the Company has categorized its impaired loans as Level 3.
Other real estate is measured at fair value on a nonrecurring basis (upon initial recognition or subsequent impairment). Other real estate is classified within Level 3 of the valuation hierarchy. When transferred from the loan portfolio, other real estate is adjusted to fair value less estimated selling costs and is subsequently carried at the lower of carrying value or fair value less estimated selling costs. The fair value is determined using an external appraisal process, discounted based on internal criteria.
In addition, mortgage loans held for sale are required to be measured at the lower of cost or fair value. The fair value of mortgage loans held for sale is based upon binding quotes or bids from third party investors. As of September 30, 2017 and December 31, 2016, all mortgage loans held for sale were recorded at cost.
The methods and assumptions used by the Company in estimating fair values of financial instruments as disclosed herein in accordance with ASC Topic 825, Financial Instruments, other than for those measured at fair value on a recurring and nonrecurring basis discussed above, are as follows:
Cash and cash equivalents: The carrying amounts of cash and cash equivalents approximate their fair value.

Certificates of deposit held in other banks: The fair value of certificates of deposit held in other banks is based upon current
rates in the market.
Loans held for sale: The fair value of loans held for sale is determined based upon commitments on hand from investors.

27





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Loans: For variable-rate loans that reprice frequently and have no significant changes in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (for example, one-to-four family residential), commercial real estate and commercial loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
Federal Home Loan Bank of Dallas and other restricted stock: The carrying value of restricted securities such as stock in the Federal Home Loan Bank of Dallas and Independent Bankers Financial Corporation approximates fair value.
Deposits: The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is their carrying amounts). The carrying amounts of variable-rate certificates of deposit (CDs) approximate their fair values at the reporting date. Fair values for fixed-rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Federal Home Loan Bank advances, line of credit and federal funds purchased: The fair value of advances maturing within 90 days approximates carrying value. Fair value of other advances is based on the Company’s current borrowing rate for similar arrangements.
Repurchase agreements and other borrowings: The carrying value of repurchase agreements approximates fair value due to the short term nature. The fair value of private subordinated debentures are based upon prevailing rates on similar debt in the market place. The subordinated debentures that are publicly traded are valued based on indicative bid prices based upon market pricing observations in the current market.
Junior subordinated debentures: The fair value of junior subordinated debentures is estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Accrued interest: The carrying amounts of accrued interest approximate their fair values.
Off-balance sheet instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of commitments is not material.

28





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial instruments were as follows at September 30, 2017 and December 31, 2016:
 
 
 
 
 
 
Fair Value Measurements at Reporting Date Using
 
 
Carrying
Amount
 
Estimated
Fair Value
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
September 30, 2017
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
763,017

 
$
763,017

 
$
763,017

 
$

 
$

Certificates of deposit held in other banks
 
15,692

 
15,800

 

 
15,800

 

Securities available for sale
 
747,147

 
747,147

 
10,362

 
736,785

 

Loans held for sale
 
25,854

 
26,728

 

 
26,728

 

Loans, net
 
6,324,545

 
6,263,277

 

 
6,259,138

 
4,139

FHLB of Dallas stock and other restricted stock
 
29,046

 
29,046

 

 
29,046

 

Accrued interest receivable
 
19,335

 
19,335

 

 
19,335

 

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits
 
6,872,631

 
6,878,244

 

 
6,878,244

 

Accrued interest payable
 
3,177

 
3,177

 

 
3,177

 

FHLB advances
 
560,687

 
555,288

 

 
555,288

 

Repurchase agreements
 
15,238

 
15,238

 

 
15,238

 

Other borrowings
 
107,567

 
111,100

 

 
111,100

 

Junior subordinated debentures
 
27,604

 
19,479

 

 
19,479

 

Off-balance sheet assets (liabilities):
 
 
 
 
 
 
 
 
 
 
Commitments to extend credit
 

 

 

 

 

Standby letters of credit
 

 

 

 

 

December 31, 2016
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
505,027

 
$
505,027

 
$
505,027

 
$

 
$

Certificates of deposit held in other banks
 
2,707

 
2,733

 

 
2,733

 

Securities available for sale
 
316,435

 
316,435

 

 
316,435

 

Loans held for sale
 
9,795

 
9,795

 

 
9,795

 

Loans, net
 
4,539,063

 
4,532,364

 

 
4,532,086

 
278

FHLB of Dallas stock and other restricted stock
 
26,536

 
26,536

 

 
26,536

 

Accrued interest receivable
 
12,331

 
12,331

 

 
12,331

 

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits
 
4,577,109

 
4,581,866

 

 
4,581,866

 

Accrued interest payable
 
4,020

 
4,020

 

 
4,020

 

FHLB advances
 
460,746

 
459,436

 

 
459,436

 

Other borrowings
 
107,299

 
110,000

 

 
110,000

 

Junior subordinated debentures
 
18,147

 
18,131

 

 
18,131

 

Off-balance sheet assets (liabilities):
 
 
 
 
 
 
 
 
 
 
Commitments to extend credit
 

 

 

 

 

Standby letters of credit
 

 

 

 

 

 

29





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 8. Stock Awards and Stock Warrants
The Company grants common stock awards to certain employees of the Company. The common stock issued prior to 2013 vests five years from the date the award is granted and the related compensation expense is recognized over the vesting period. In connection with the initial public offering in April 2013, the Board of Directors adopted a new 2013 Equity Incentive Plan. Under this plan, the Compensation Committee may grant awards in the form of restricted stock, restricted stock rights, restricted stock units, qualified and nonqualified stock options, performance-based share awards and other equity-based awards. The Plan reserved 800,000 shares of common stock to be awarded by the Company’s compensation committee. The shares currently issued under the 2013 Plan are restricted and will vest evenly over the required employment period, generally ranging from three to five years. Shares granted under a previous plan prior to 2012 and those in and subsequent to 2013 under the 2013 Equity Incentive Plan were issued at the date of grant and receive dividends. Shares issued under a revised plan in 2012 are not outstanding shares of the Company until they vest and do not receive dividends. During the nine months ended September 30, 2017, 24,160 shares that were issued under the 2012 Plan vested during the period.
The following table summarizes the activity in nonvested shares for the nine months ended September 30, 2017 and 2016:   
   
 
Number of
Shares
 
Weighted Average
Grant Date
Fair Value
Nonvested shares, December 31, 2016
 
280,524

 
$
36.88

Granted during the period
 
102,570

 
61.90

Vested during the period
 
(135,220
)
 
34.10

Forfeited during the period
 
(67
)
 
29.91

Nonvested shares, September 30, 2017
 
247,807

 
$
48.76

 
 
 
 
 
Nonvested shares, December 31, 2015
 
373,572

 
$
40.29

Granted during the period
 
87,470

 
31.82

Vested during the period
 
(139,699
)
 
36.55

Forfeited during the period
 
(6,836
)
 
36.11

Nonvested shares, September 30, 2016
 
314,507

 
$
36.35

Compensation expense related to these awards is recorded based on the fair value of the award at the date of grant and totaled $1,276 and $3,442 for the three and nine months ended September 30, 2017, respectively and $892 and $4,533 for the three and nine months ended September 30, 2016, respectively. Compensation expense is recorded in salaries and employee benefits in the accompanying consolidated statements of income. At September 30, 2017, future compensation expense is estimated to be $9,345 and will be recognized over a remaining weighted average period of 3.03 years.
The fair value of common stock awards that vested during the nine months ended September 30, 2017 and 2016 was $8,243 and $4,554, respectively. The Company has recorded $28 and $1,272 in excess tax benefits on vested restricted stock to income tax expense for the three and nine months ended September 30, 2017, respectively, as a result of adopting ASU 2016-09. The Company recorded $185 and $(193) to additional paid in capital, which represents the income tax benefit (deficiency) recognized on the vested shares for the three and nine months ended September 30, 2016, respectively.
At September 30, 2017, the future vesting schedule of the nonvested shares is as follows:
First year
 
115,069

Second year
 
75,945

Third year
 
31,723

Fourth year
 
15,456

Fifth year
 
9,614

Total nonvested shares
 
247,807

The Company has warrants outstanding representing the right to purchase 147,341 shares of Company stock at $17.19 per share to certain Company directors and shareholders. The warrants were issued in return for the shareholders' agreement to repurchase the subordinated debt outstanding to an unaffiliated bank in the event of Company default. The warrants were recorded as equity awards at fair value and were amortized over the term of the debt. The subordinated debt was paid off by the

30





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Company in 2013. The warrants expire in December 2018. During the nine months ended September 30, 2017, warrants to purchase 3,203 shares of common stock were exercised and have been issued by the Company.


Note 9. Regulatory Matters

Under banking law, there are legal restrictions limiting the amount of dividends the Bank can declare. Approval of the regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. For state banks, subject to regulatory capital requirements, payment of dividends is generally allowed to the extent of net profits.

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Company is subject to the Basel III regulatory capital framework (the "Basel III Capital Rules"). Starting in January 2016, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reaches 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on the Company's ability to make capital distributions, including dividend payments and stock repurchases and to pay discretionary bonuses to executive officers.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total, CET1 and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2017 and December 31, 2016, the Company and the Bank meet all capital adequacy requirements to which they are subject, including the capital buffer requirement.

As of September 30, 2017 and December 31, 2016, the Bank’s capital ratios exceeded those levels necessary to be categorized as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized," the Bank must maintain minimum total risk based, CET1, Tier 1 risk based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s category.


















31





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The actual capital amounts and ratios of the Company and Bank as of September 30, 2017 and December 31, 2016, are presented in the following table:
 
   
 
Actual
 
Minimum for Capital
Adequacy Purposes
 
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
   
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
September 30, 2017
 
   
 
   
 
   
 
   
 
   
 
   
Total capital to risk weighted assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
$
818,998

 
11.72
%
 
$
559,083

 
8.00
%
 
 N/A

 
 N/A

Bank
 
793,048

 
11.37

 
557,977

 
8.00

 
$
697,471

 
10.00
%
Tier 1 capital to risk weighted assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
671,228

 
9.60

 
419,312

 
6.00

 
 N/A

 
 N/A

Bank
 
755,269

 
10.83

 
418,483

 
6.00

 
557,977

 
8.00

Common equity tier 1 to risk weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
641,114

 
9.17

 
314,484

 
4.50

 
 N/A

 
 N/A

Bank
 
755,269

 
10.83

 
313,862

 
4.50

 
453,356

 
6.50

Tier 1 capital to average assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
671,228

 
8.30

 
323,599

 
4.00

 
 N/A

 
 N/A

Bank
 
755,269

 
9.35

 
323,037

 
4.00

 
403,797

 
5.00

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
   
 
   
 
   
 
   
 
   
 
   
Total capital to risk weighted assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
$
568,808

 
11.38
%
 
$
399,698

 
8.00
%
 
N/A

 
N/A

Bank
 
558,551

 
11.19

 
399,497

 
8.00

 
$
499,371

 
10.00
%
Tier 1 capital to risk weighted assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
427,217

 
8.55

 
299,774

 
6.00

 
N/A

 
N/A

Bank
 
526,960

 
10.55

 
299,623

 
6.00

 
399,497

 
8.00

Common equity tier 1 to risk weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
409,617

 
8.20

 
224,830

 
4.50

 
 N/A

 
N/A

Bank
 
526,960

 
10.55

 
224,717

 
4.50

 
324,591

 
6.50

Tier 1 capital to average assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
427,217

 
7.82

 
218,612

 
4.00

 
N/A

 
N/A

Bank
 
526,960

 
9.65

 
218,517

 
4.00

 
273,146

 
5.00



Note 10. Business Combination

Carlile Bancshares, Inc.

On April 1, 2017, the Company acquired 100% of the outstanding stock of Carlile. This transaction resulted in 24 additional branches in the DFW Metroplex and Austin area as well as 18 branches in Colorado. The Company issued 8,804,699 shares of Company stock and paid $17,773 in cash for the outstanding shares of Carlile common stock. Subsequent to September 30, 2017, the Company sold nine of the acquired Colorado branches as further explained in Note 11.

The Company has recognized total goodwill of $348,382 which is calculated as the excess of both the consideration exchanged and liabilities assumed compared to the fair market value of identifiable assets acquired. The goodwill in this acquisition resulted from a combination of expected synergies and entrance into desirable Texas and Colorado markets. None of the goodwill recognized is expected to be deductible for income tax purposes.



32





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The Company has incurred expenses related to the acquisition of approximately $2,558 and $9,664 for the three and nine months ended September 30, 2017, respectively, which are included in noninterest expense in the consolidated statements of income. The Company incurred expenses of $659 during the year ended December 31, 2016. In addition, for the nine months ended September 30, 2017, the Company paid offering costs totaling $942 which were recorded as a reduction to stock issuance proceeds through additional paid in capital.

Estimated fair values of the assets acquired and liabilities assumed in this transaction as of the closing date and subsequent measurement period adjustments are as follows:
Assets of acquired bank:
Initially Recorded at Acquisition Date
Measurement Period Adjustments
Adjusted Values
Cash, cash equivalents, and certificates of deposit
$
159,469

$

$
159,469

Securities available for sale
336,540


336,540

Loans
1,384,041

169

1,384,210

Premises and equipment
63,561

(395
)
63,166

Other real estate owned
9,976

1,148

11,124

Goodwill
348,944

(562
)
348,382

Core deposit intangible
36,717


36,717

Other assets
89,624

(104
)
89,520

Total assets acquired
$
2,428,872

$
256

$
2,429,128

 

 
 
Liabilities of acquired bank:
 
 
 
Deposits
$
1,821,938

$

$
1,821,938

Junior subordinated debentures
9,359


9,359

Other liabilities
27,709

256

27,965

Total liabilities assumed
$
1,859,006

$
256

$
1,859,262

Common stock issued at $62.70 per share
$
552,093

$

$
552,093

Cash paid
$
17,773

$

$
17,773


The income effects resulting from the recorded measurement period adjustments during the period ending September 30, 2017 are immaterial for separate disclosure.

Non-credit impaired loans had an estimated fair value of $1,299,602 at acquisition date and contractual balance of $1,310,420. As of acquisition date, the Company expects that an insignificant amount of the contractual balance of these loans will be uncollectible. The difference of $10,818 will be recognized into interest income as an adjustment to yield over the life of the loans.














33





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The following table presents pro forma information as if the Carlile acquisition was completed as of January 1, 2016. The pro forma results combine the historical results of Carlile into the Company's consolidated statement of income including the impact of certain purchase accounting adjustments including loan discount accretion, intangible assets amortization, and junior subordinated debentures discount amortization. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1 of each year.
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
(Dollars in thousands)
2017
 
2016
 
2017
 
2016
 
Interest income
$
84,672

 
$
76,063

 
$
243,892

 
$
224,918

 
Noninterest income
12,130

 
12,756

 
34,586

 
35,751

 
Total Revenue
96,802

 
88,819

 
278,478

 
260,669

 
Net income (1)
25,177

 
21,003

 
68,457

 
56,733

 
Net income attributable to noncontrolling interests

 

 

 
(315
)
 
Net income to common stockholders
$
25,177

 
$
21,003

 
$
68,457

 
$
56,418

 
Basic earnings per share
$
0.91

 
$
0.76

 
$
2.47

 
$
2.04

 
Diluted earnings per share
$
0.90

 
$
0.76

 
$
2.46

 
$
2.03

 
(1) Excludes acquisition / restructure related costs incurred by the Company of $2.6 million and $9.7 million for the three and nine months ended September 30, 2017, respectively, and acquisition / change of control related costs incurred by Carlile of $0 million and $15.7 million for the three and nine months ended September 30, 2017, respectively, and related tax effects.
 
Revenues and earnings of the acquired company since the acquisition date have not been disclosed as Carlile was merged into the Company and separate financial information is not readily available.

Note 11. Subsequent Events

Branch Sales

On October 6, 2017, the Bank completed the sale of nine of its Colorado branches to an unaffiliated commercial bank. Approximately $99 million in loans and $161 million in deposits were transferred in the sale. The Bank received a deposit premium of approximately $6.8 million from the sale. Management believes the financial effects of the sale will have minimal impact on the Company's continued operations and financial condition.

Line of Credit Amendment

On October 20, 2017, the Company's unsecured line of credit with two unrelated commercial banks was amended with only one of the commercial banks to extend the termination date. The line bears interest at LIBOR plus 2.5% and matures on October 19, 2018. As of September 30, 2017, there were no advances outstanding on these lines.

Declaration of Dividends

On October 25, 2017, the Company declared a quarterly cash dividend in the amount of $0.10 per share of common stock to the stockholders of record on November 6, 2017. The dividend will be paid on November 16, 2017.




34





ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Note Regarding Forward Looking Statements
This Quarterly Report on Form 10-Q, our other filings with the SEC, and other press releases, documents, reports and announcements that we make, issue or publish may contain statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are statements or projections with respect to matters such as our future results of operations, including our future revenues, income, expenses, provision for taxes, effective tax rate, earnings per share and cash flows, our future capital expenditures and dividends, our future financial condition and changes therein, including changes in our loan portfolio and allowance for loan losses, our future capital structure or changes therein, the plan and objectives of management for future operations, our future or proposed acquisitions and the integration thereof, the future or expected effect of acquisitions on our operations, results of operations and financial condition, our future economic performance and the statements of the assumptions underlying any such statement. Such statements are typically identified by the use in the statements of words or phrases such as “aim,” “anticipate,” “estimate,” “expect,” “goal,” “guidance,” “intend,” “is anticipated,” “is estimated,” “is expected,” “is intended,” “objective,” “plan,” “projected,” “projection,” “will affect,” “will be,” “will continue,” “will decrease,” “will grow,” “will impact,” “will increase,” “will incur,” “will reduce,” “will remain,” “will result,” “would be,” variations of such words or phrases (including where the word “could”, “may” or “would” is used rather than the word “will” in a phrase) and similar words and phrases indicating that the statement addresses some future result, occurrence, plan or objective. The forward-looking statements that we make are based on the Company’s current expectations and assumptions regarding its business, the economy, and other future conditions. Because forward-looking statements relate to future results and occurrences, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. The Company’s actual results may differ materially from those contemplated by the forward-looking statements, which are neither statements of historical fact nor guarantees or assurances of future performance. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in forward-looking statements. These factors include, but are not limited to, the following:
our ability to sustain our current internal growth rate and total growth rate;
changes in geopolitical, business and economic events, occurrences and conditions, including changes in rates of inflation or deflation, nationally, regionally and in our target markets, particularly in Texas and Colorado;
worsening business and economic conditions nationally, regionally and in our target markets, particularly in Texas and Colorado, and the geographic areas in those states in which we operate;
our dependence on our management team and our ability to attract, motivate and retain qualified personnel;
the concentration of our business within our geographic areas of operation in Texas and Colorado;
changes in asset quality, including increases in default rates and loans and higher levels of nonperforming loans and loan charge-offs;
concentration of the loan portfolio of Independent Bank, before and after the completion of acquisitions of financial institutions,in commercial and residential real estate loans and changes in the prices, values and sales volumes of commercial and residential real estate, values and dales volumes of commercial and residential real estate;
the ability of Independent Bank to make loans with acceptable net interest margins and levels of risk of repayment and to otherwise invest in assets at acceptable yields and presenting acceptable investment risks;
inaccuracy of the assumptions and estimates that the managements of our Company and the financial institutions that we acquire make in establishing reserves for probable loan losses and other estimates;
lack of liquidity, including as a result of a reduction in the amount of sources of liquidity we currently have;
material increases or decreases in the amount of deposits held by Independent Bank or other financial institutions that we acquire and the cost of those deposits;
our access to the debt and equity markets and the overall cost of funding our operations;
regulatory requirements to maintain minimum capital levels or maintenance of capital at levels sufficient to support our anticipated growth;
changes in market interest rates that affect the pricing of the loans and deposits of each of Independent Bank and the financial institutions that we acquire and the net interest income of each of Independent Bank and the financial institutions that we acquire;
fluctuations in the market value and liquidity of the securities we hold for sale, including as a result of changes in market interest rates;
effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
changes in economic and market conditions that affect the amount and value of the assets of Independent Bank and of financial institutions that we acquire;

35





the institution and outcome of, and costs associated with, litigation and other legal proceedings against one of more of us, Independent Bank and financial institutions that we acquire or to which any of such entities is subject;
the occurrence of market conditions adversely affecting the financial industry generally;
the impact of recent and future legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, specifically the Dodd-Frank Act stress testing requirements as we approach $10 billion in total assets, and changes in federal government policies, including as a result of the administration of President Donald J. Trump;
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the SEC and the Public Company Accounting Oversight Board, as the case may be;
governmental monetary and fiscal policies;
changes in the scope and cost of FDIC insurance and other coverage;
the effects of war or other conflicts, acts of terrorism (including cyber attacks) or other catastrophic events, including storms, droughts, tornadoes, hurricanes and flooding, that may affect general economic conditions;
our actual cost savings resulting from previous or future acquisitions are less than expected, we are unable to realize those cost savings as soon as expected, or we incur additional or unexpected costs;
our revenues after previous or future acquisitions are less than expected;
the liquidity of, and changes in the amounts and sources of liquidity available to, us, before and after the acquisition of any financial institutions that we acquire;
deposit attrition, operating costs, customer loss and business disruption before and after our completed acquisitions, including, without limitation, difficulties in maintaining relationships with employees, may be greater than we expected;
the effects of the combination of the operations of financial institutions that we have acquired in the recent past or may acquire in the future with our operations and the operations of Independent Bank, the effects of the integration of such operations being unsuccessful, and the effects of such integration being more difficult, time-consuming or costly than expected or not yielding the cost savings that we expect;
the impact of investments that we or Independent Bank may have made or may make and the changes in the value of those investments;
the quality of the assets of financial institutions and companies that we have acquired in the recent past or may acquire in the future being different than we determined or determine in our due diligence investigation in connection with the acquisition of such financial institutions and any inadequacy of loan loss reserves relating to, and exposure to unrecoverable losses on, loans acquired;
our ability to continue to identify acquisition targets and successfully acquire desirable financial institutions to sustain our growth, to expand our presence in our markets and to enter new markets;
general business and economic conditions in our markets change or are less favorable than expected;
changes occur in business conditions and inflation;
an increase in the rate of personal or commercial customers’ bankruptcies;
technology-related changes are harder to make or are more expensive than expected;
attacks on the security of, and breaches of, our Independent Bank's digital information systems, the costs we or Independent Bank incur to provide security against such attacks and any costs and liability we or Independent Bank incurs in connection with any breach of those systems;
the potential impact of technology and "FinTech" entities on the banking industry generally; and
the other factors that are described or referenced in Part II, Item 1A. of this Quarterly Report on Form 10-Q under the caption “Risk Factors” or in Part I, Item 1A, of our most recently filed Annual Report on Form 10-K under the caption "Risk Factors."

We urge you to consider all of these risks, uncertainties and other factors carefully in evaluating all such forward-looking statements that we may make. As a result of these and other matters, including changes in facts and assumptions not being realized, the actual results relating to the subject matter of any forward-looking statement may differ materially from the anticipated results expressed or implied in that forward-looking statement. Any forward-looking statement made by the Company in any report, filing, press release, document, report or announcement speaks only as of the date on which it is made. The Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.
A forward looking-statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

36





Overview
This Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company’s financial condition and results of operation as reflected in the interim consolidated financial statements and accompanying notes appearing in this Quarterly Report on Form 10-Q. This section should be read in conjunction with the Company’s interim consolidated financial statements and accompanying notes included elsewhere in this report and with the consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2016.

The Company was organized as a bank holding company in 2002. On January 1, 2009, the Company was merged with Independent Bank Group Central Texas, Inc., and, since that time, has pursued a strategy to create long-term shareholder value through organic growth of our community banking franchise in our market areas and through selective acquisitions of complementary banking institutions with operations in our market areas. On April 8, 2013, the Company consummated the initial public offering, or IPO, of its common stock which is traded on the Nasdaq Global Select Market.

The Company closed the Carlile acquisition on April 1, 2017. As of September 30, 2017, the Company operated 79 full service banking locations in north, central and southeast Texas regions, and along the Colorado Front Range region. During the nine months ended September 30, 2017, as part of the integration process of Carlile, the Company restructured the Northstar Bank branch system acquired in the acquisition and sold one branch location and closed three other locations, two of which were merged into existing branches. In addition, on October 6, 2017, the Bank completed the sale of nine of its Colorado branches to an unaffiliated commercial bank. Management believes the financial effects of these transactions will have minimal impact on the Company's continued operations and financial condition.

The Company’s headquarters are located at 1600 Redbud, Suite 400, McKinney, Texas 75069, and its telephone number is (972) 562-9004. The Company’s website address is www.ibtx.com. Information contained on the Company’s website is not incorporated by reference into this Quarterly Report on Form 10-Q and is not part of this or any other report.
Our principal business is lending to and accepting deposits from businesses, professionals and individuals. We conduct all of our banking operations through Independent Bank, which is a Texas state banking corporation and our principal subsidiary (the Bank). We derive our income principally from interest earned on loans and, to a lesser extent, income from securities available for sale. We also derive income from non-interest sources, such as fees received in connection with various deposit services and mortgage brokerage operations. From time to time, we also realize gains on the sale of assets. Our principal expenses include interest expense on interest-bearing customer deposits, advances from the Federal Home Loan Bank of Dallas, or the FHLB, and other borrowings, operating expenses, such as salaries, employee benefits, occupancy costs, data processing and communication costs, expenses associated with other real estate owned, other administrative expenses, provisions for loan losses and our assessment for FDIC deposit insurance.

Certain Events Affect Year-over-Year Comparability
Acquisition. The Company completed the acquisition of Carlile Bancshares, Inc., a Texas corporation ("Carlile") and its subsidiary, Northstar Bank, Denton, Texas, a Texas state chartered bank on April 1, 2017. This acquisition increased total assets by $2.4 billion, gross loans by $1.4 billion and deposits by $1.8 billion.
The comparability of the Company's consolidated financial condition as of December 31, 2016 and September 30, 2017 and results of operations for the three and nine months ended September 30, 2017 and 2016 are affected by this acquisition.





37





Discussion and Analysis of Results of Operations for the Three and Nine Months Ended September 30, 2017 and 2016

The following discussion and analysis of our results of operations compares the operations for the three and nine months ended September 30, 2017 with the three and nine months ended September 30, 2016. The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the results of operations that may be expected for all of the year ending December 31, 2017.
Results of Operations
For the three months ended September 30, 2017, net income was $23.5 million ($0.84 per common share on a diluted basis) compared with net income of $14.5 million ($0.78 per common share on a diluted basis) for the three months ended September 30, 2016. The Company posted annualized returns on average equity of 7.33% and 9.04%, returns on average assets of 1.07% and 1.04% and efficiency ratios of 54.71% and 52.09% for the three months ended September 30, 2017 and 2016, respectively. The efficiency ratio is calculated by dividing total noninterest expense (which excludes the provision for loan losses and the amortization of core deposits intangibles) by net interest income plus noninterest income.
For the nine months ended September 30, 2017, net income was $57.3 million ($2.30 per common share on a diluted basis) compared with $38.8 million ($2.09 per common share on a diluted basis) for the nine months ended September 30, 2016. The Company posted annualized returns on average common equity of 7.16% and 8.25%, returns on average assets of 0.99% and 0.96% and efficiency ratios of 56.88% and 57.01% for the nine months ended September 30, 2017 and 2016, respectively.
Net Interest Income
The Company’s net interest income is its interest income, net of interest expenses. Changes in the balances of the Company’s earning assets and its deposits, FHLB advances and other borrowings, as well as changes in the market interest rates, affect the Company’s net interest income. The difference between the Company’s average yield on earning assets and its average rate paid for interest-bearing liabilities is its net interest spread. Noninterest-bearing sources of funds, such as demand deposits and stockholders’ equity, also support the Company’s earning assets. The impact of the noninterest-bearing sources of funds is reflected in the Company’s net interest margin, which is calculated as annualized net interest income divided by average earning assets.
Net interest income was $72.9 million for the three months ended September 30, 2017, an increase of $27.2 million, or 59.3%, from $45.7 million for the three months ended September 30, 2016. This increase is due primarily to a $2.5 billion increase, or 51.3%, in average interest earning assets to $7.5 billion for the three months ended September 30, 2017 compared to $5.0 billion for the three months ended September 30, 2016. The increases in interest-earning assets and interest-bearing deposits is primarily due to the acquisition of Carlile Bancshares in April 2017 as well as organic growth. The average yield on interest earning assets increased 25 basis points from 4.22% for the three months ended September 30, 2016 to 4.47% for the three months ended September 30, 2017 primarily due to loans and taxable securities acquired in the Carlile transaction, which had higher effective interest rates as well as increased interest rates on interest-bearing deposits which are tied to the Fed Funds rate. The average cost of interest-bearing liabilities increased 10 basis points to 0.84% for the three months ended September 30, 2017 compared to 0.74% for the three months ended September 30, 2016. The increase from the prior year is primarily due to higher rates offered on public fund certificates of deposit and money market accounts due to competition in our markets but also due in part to increased interest rates on deposit products tied to Fed Funds rate and short-term FHLB advances. The aforementioned changes resulted in a 19 basis point increase in the net interest margin for the three months ended September 30, 2017 at 3.85% compared to 3.66% for the three months ended September 30, 2016.
Net interest income was $190.2 million for the nine months ended September 30, 2017, an increase of $52.9 million, or 38.6%, from $137.3 million for the nine months ended September 30, 2016. This increase is due primarily to a $2.0 billion increase, or 42.7%, in average interest earning assets to $6.7 billion for the nine months ended September 30, 2017 compared to $4.7 billion for nine months ended September 30, 2016. The increases in interest-earning assets and interest-bearing deposits is due to organic growth and the result of the Carlile acquisition completed in April 2017. The net interest margin for the nine months ended September 30, 2017 decreased 10 basis points to 3.79% compared to 3.89% for the nine months ended September 30, 2016. The decrease from prior year is primarily due to an increase in the average cost on total deposits of 11 basis points from prior year which is reflective of the increased interest rates on deposit products as mentioned above in addition to a decrease in the average yield on earning assets due to a flattened yield curve and a shift to a higher mix of variable rate loans in the second half of 2016. The average yield on interest earning assets decreased 4 basis points from 4.43% for the nine months ended September 30, 2016 to 4.39% while the average rate paid on interest bearing liabilities increased 12 basis points from 0.68% to 0.80%.

38





Average Balance Sheet Amounts, Interest Earned and Yield Analysis.  The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three and nine months ended September 30, 2017 and 2016. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances.
   
 
Three Months Ended September 30,
   
 
2017
 
2016
   
 
Average
Outstanding
Balance
 
Interest
 
Yield/
Rate
(3)
 
Average
Outstanding
Balance
 
Interest
 
Yield/
Rate
(3)
(dollars in thousands)
 
   
 
   
 
   
 
   
 
   
 
   
Interest-earning assets:
 
   
 
   
 
   
 
   
 
   
 
   
Loans (1)
 
$
6,286,990

 
$
79,325

 
5.01
%
 
$
4,302,570

 
$
51,194

 
4.73
%
Taxable securities
 
576,770

 
2,539

 
1.75

 
218,286

 
573

 
1.04

Nontaxable securities
 
188,053

 
1,124

 
2.37

 
75,559

 
394

 
2.07

Interest-bearing deposits and other
 
461,092

 
1,684

 
1.45

 
370,011

 
579

 
0.62

Total interest-earning assets
 
7,512,905

 
$
84,672

 
4.47

 
4,966,426

 
$
52,740

 
4.22

Noninterest-earning assets
 
1,213,942

 
   
 
   
 
568,777

 
   
 
   
Total assets
 
$
8,726,847

 
   
 
   
 
$
5,535,203

 
   
 
   
Interest-bearing liabilities:
 
   
 
   
 
   
 
   
 
   
 
   
Checking accounts
 
$
2,864,775

 
$
4,102

 
0.57

 
$
1,791,228

 
$
1,946

 
0.43

Savings accounts
 
306,380

 
104

 
0.13

 
153,526

 
66

 
0.17

Money market accounts
 
619,051

 
1,459

 
0.94

 
396,441

 
474

 
0.48

Certificates of deposit
 
1,074,883

 
2,368

 
0.87

 
821,283

 
1,563

 
0.76

Total deposits
 
4,865,089

 
8,033

 
0.66

 
3,162,478

 
4,049

 
0.51

FHLB advances
 
541,129

 
1,749

 
1.28

 
494,141

 
1,063

 
0.86

Repurchase agreements and other borrowings
 
123,285

 
1,716

 
5.52

 
107,284

 
1,733

 
6.43

Junior subordinated debentures
 
27,587

 
317

 
4.56

 
18,147

 
158

 
3.46

Total interest-bearing liabilities
 
5,557,090

 
11,815

 
0.84

 
3,782,050

 
7,003

 
0.74

Noninterest-bearing checking accounts
 
1,863,971

 
   
 
   
 
1,100,613

 
   
 
   
Noninterest-bearing liabilities
 
33,836

 
   
 
   
 
14,185

 
   
 
   
Stockholders’ equity
 
1,271,950

 
   
 
   
 
638,355

 
   
 
   
Total liabilities and equity
 
$
8,726,847

 
   
 
   
 
$
5,535,203

 
   
 
   
Net interest income
 
   
 
$
72,857

 
   
 
   
 
$
45,737

 
   
Interest rate spread
 
   
 
   
 
3.63
%
 
   
 
   
 
3.48
%
Net interest margin (2)
 
   
 
   
 
3.85

 
   
 
   
 
3.66

Average interest earning assets to interest bearing liabilities
 
   
 
   
 
135.19

 
   
 
   
 
131.32

(1)
Average loan balances include nonaccrual loans.
(2)
Net interest margins for the periods presented represent: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.
(3)
Yield and rates for the three month periods are annualized.





39






   
 
For The Nine Months Ended September 30,
   
 
2017
 
2016
   
 
Average
Outstanding
Balance
 
Interest
 
Yield/
Rate
(3)
 
Average
Outstanding
Balance
 
Interest
 
Yield/
Rate
(3)
(dollars in thousands)
 
   
 
   
 
   
 
   
 
   
 
   
Interest-earning assets:
 
   
 
   
 
   
 
   
 
   
 
   
Loans (1)
 
$
5,701,324

 
$
208,263

 
4.88
%
 
$
4,170,930

 
$
151,522

 
4.85
%
Taxable securities
 
452,317

 
5,606

 
1.66

 
220,176

 
2,067

 
1.25

Nontaxable securities
 
144,132

 
2,657

 
2.46

 
73,761

 
1,289

 
2.33

Interest-bearing deposits and other
 
420,330

 
3,968

 
1.26

 
243,827

 
1,267

 
0.69

Total interest-earning assets
 
6,718,103

 
$
220,494

 
4.39

 
4,708,694

 
$
156,145

 
4.43

Noninterest-earning assets
 
990,811

 
   
 
 
 
673,676

 
   
 
 
Total assets
 
$
7,708,914

 
   
 
 
 
$
5,382,370

 
   
 
 
Interest-bearing liabilities:
 
 
 
   
 
 
 
   
 
   
 
 
Checking accounts
 
$
2,510,550

 
$
8,828

 
0.47

 
$
1,718,458

 
$
5,689

 
0.44

Savings accounts
 
255,602

 
267

 
0.14

 
149,080

 
196

 
0.18

Money market accounts
 
610,819

 
4,451

 
0.97

 
434,010

 
1,385

 
0.43

Certificates of deposit
 
1,025,997

 
6,497

 
0.85

 
817,693

 
4,353

 
0.71

Total deposits
 
4,402,968

 
20,043

 
0.61

 
3,119,241

 
11,623

 
0.50

FHLB advances
 
487,820

 
4,271

 
1.17

 
463,811

 
3,062

 
0.88

Repurchase agreements and other borrowings
 
118,331

 
5,137

 
5.80

 
81,454

 
3,723

 
6.11

Junior subordinated debentures
 
24,448

 
819

 
4.48

 
18,147

 
457

 
3.36

Total interest-bearing liabilities
 
5,033,567

 
30,270

 
0.80

 
3,682,653

 
18,865

 
0.68

Noninterest-bearing checking accounts
 
1,578,061

 
   
 
   
 
1,059,202

 
   
 
   
Noninterest-bearing liabilities
 
26,234

 
   
 
   
 
12,207

 
   
 
   
Stockholders’ equity
 
1,071,052

 
   
 
   
 
628,308

 
   
 
   
Total liabilities and equity
 
$
7,708,914

 
   
 
   
 
$
5,382,370

 
   
 
   
Net interest income
 
   
 
$
190,224

 
   
 
   
 
$
137,280

 
   
Interest rate spread
 
   
 
   
 
3.59
%
 
   
 
   
 
3.75
%
Net interest margin (2)
 
   
 
   
 
3.79

 
   
 
   
 
3.89

Average interest earning assets to interest bearing liabilities
 
   
 
   
 
133.47

 
   
 
   
 
127.86

(1)
Average loan balances include nonaccrual loans.
(2)
Net interest margins for the periods presented represent: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.
(3)
Yield and rates for the nine month periods are annualized.



40





Provision for Loan Losses
Management actively monitors the Company’s asset quality and provides specific loss provisions when necessary. Provisions for loan losses are charged to income to bring the total allowance for loan losses to a level deemed appropriate by management based on such factors as historical loss experience, trends in classified loans and past dues, the volume, concentrations, and growth in the loan portfolio, current economic conditions and the value of collateral.
Loans are charged off against the allowance for loan losses when determined appropriate. Although management believes it uses the best information available to make determinations with respect to the provision for loan losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the determination.
The Company recorded a $1.9 million provision for loan losses for the three months ended September 30, 2017 compared to $2.1 million for the comparable period in 2016. Provision expense for the nine months ended September 30, 2017 was $6.4 million compared to $7.2 million for the same period in 2016. Provision expense is directly related to organic loan growth and net charge-offs during the respective periods. The increased provision for the nine months ended September 2016 also reflected increased reserve allocations related to the risks associated with the energy portfolio due to commodity price volatility during the majority of 2016. Net charge-offs (recoveries) were $(16) thousand and $3.5 million for the three months ended September 30, 2017 and 2016, respectively and $189 thousand and $4.7 million for the nine months ended September 30, 2017 and 2016, respectively. The higher level of charge-offs in 2016 is due to charge-offs on energy related credits.
Noninterest Income
The following table sets forth the components of noninterest income for the three and nine months ended September 30, 2017 and 2016 and the period-over-period variations in such categories of noninterest income:
 
Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
(dollars in thousands)
2017
 
2016
 
2017 v. 2016
 
2017
 
2016
 
2017 v. 2016
Noninterest Income
 
 
 
 
 
 
 
 
 
 
 
Service charges on deposit accounts
$
3,677

 
$
1,840

 
$
1,837

 
$
9,364

 
$
5,287

 
$
4,077

Mortgage fee income
4,569

 
1,922

 
2,647

 
10,855

 
5,319

 
5,536

Gain on sale of loans
351

 

 
351

 
351

 

 
351

Loss on sale of branch
(127
)
 
(43
)
 
(84
)
 
(127
)
 
(43
)
 
(84
)
Gain (loss) on sale of other real estate

 
4

 
(4
)
 
(36
)
 
57

 
(93
)
Gain on sale of securities available for sale

 

 

 
52

 
4

 
48

(Loss) gain on sale of premises and equipment
(21
)
 
(9
)
 
(12
)
 
(15
)
 
32

 
(47
)
Increase in cash surrender value of BOLI
778

 
402

 
376

 
1,959

 
937

 
1,022

Other
2,903

 
816

 
2,087

 
5,305

 
2,738

 
2,567

Total noninterest income
$
12,130

 
$
4,932

 
$
7,198

 
$
27,708

 
$
14,331

 
$
13,377

Total noninterest income increased $7.2 million, or 145.9% and $13.4 million, or 93.3% for the three and nine months ended September 30, 2017 over same periods in 2016. Significant changes in the components of noninterest income are discussed below.
Service charges on deposit accounts. Service charges on deposit accounts increased $1.8 million, or 99.8% and $4.1 million, or 77.1%, respectively for the three and nine months ended September 30, 2017, as compared to the same periods in 2016. The increase in service charge income reflects an increase in deposit accounts due to organic growth and the acquisition of Carlile in April 2017. In addition, the Company implemented a new deposit fee schedule in late 2016 which increased organic service charges for the year over year period.
Mortgage fee income. Mortgage fee income for the three and nine months ended September 30, 2017 increased $2.6 million, or 137.7% and $5.5 million, or 104.1%, respectively compared to the same periods in 2016. The increase in both periods is reflective of the retail mortgage line of business acquired with the acquisition of Carlile.
Gain on sale of loans. The Company recognized a net gain of $351 thousand on the sale of loans for the three and nine months ended September 30, 2017. The majority of the gain recognized is due to the sale of an acquired loan that resulted in a $312 thousand gain.

41





Increase in cash surrender value of bank owned life insurance (BOLI). BOLI income increased $376 thousand, or 93.5% and $1.0 million, or 109.1% for the three and nine months ended September 30, 2017, respectively as compared to the same periods in 2016. The increase for both periods is the result of $53.2 million in BOLI policies acquired in the Carlile transaction.
Other noninterest income. Other noninterest income increased $2.1 million, or 255.8% and $2.6 million, or 93.8% for the three and nine months ended September 30, 2017, respectively as compared to the same periods in 2016. A large portion of the increases from prior periods is due to recoveries recognized on loans charged off prior to acquisition as well as increased merchant card income and increased earnings credits on correspondent accounts.
Noninterest Expense
Noninterest expense increased $21.0 million, or 78.2% and $40.8 million, or 47.2% for the three and nine months ended September 30, 2017, respectively, as compared to the same periods in 2016. The following table sets forth the components of the Company’s noninterest expense for the three and nine months ended September 30, 2017 and 2016 and the period-over-period variations in such categories of noninterest expense:

Three Months Ended September 30,
 
Variance
 
Nine Months Ended September 30,
 
Variance
(dollars in thousands)
2017
 
2016
 
2017 v. 2016
 
2017
 
2016
 
2017 v. 2016
Noninterest Expense
 
 
 
 
 
 
 
 
 
 
 
Salaries and employee benefits
$
25,684

 
$
15,303

 
$
10,381

 
$
69,610

 
$
51,644

 
$
17,966

Occupancy
6,380

 
4,038

 
2,342

 
16,399

 
12,119

 
4,280

Data processing
2,546

 
1,190

 
1,356

 
6,449

 
3,575

 
2,874

FDIC assessment
1,077

 
1,123

 
(46
)
 
3,156

 
2,718

 
438

Advertising and public relations
380

 
229

 
151

 
994

 
775

 
219

Communications
771

 
563

 
208

 
2,098

 
1,648

 
450

Net other real estate owned expenses (including taxes)
61

 
145

 
(84
)
 
223

 
180

 
43

Other real estate impairment
917

 
51

 
866

 
1,037

 
106

 
931

Core deposit intangible amortization
1,409

 
492

 
917

 
3,311

 
1,472

 
1,839

Professional fees
1,273

 
717

 
556

 
3,212

 
2,354

 
858

Acquisition expense, including legal
2,428

 
3

 
2,425

 
8,247

 
732

 
7,515

Other
4,978

 
3,033

 
1,945

 
12,524

 
9,106

 
3,418

Total noninterest expense
$
47,904

 
$
26,887

 
$
21,017

 
$
127,260

 
$
86,429

 
$
40,831


Salaries and Employee Benefits. Salary and employee benefits increased $10.4 million and $18.0 million, or 67.8% and 34.8%, respectively for the three and nine months ended September 30, 2017 compared to the same periods in 2016. Salaries and employee benefits expenses increased in 2017 over the same prior year periods due to an increase in the number of the Company’s full-time equivalent employees both resulting from the acquisition of Carlile, which includes closing and retention bonuses of $1.2 million in second quarter 2017, and organic growth within the Company. In addition, commissions paid to our mortgage lenders increased related to our retail mortgage line of business.
Occupancy.  Occupancy expense increased by $2.3 million and $4.3 million, or 58.0% and 35.3%, respectively for the three and nine months ended September 30, 2017 compared to the same periods in 2016. The increase for both periods is reflective of additional branches acquired in the Carlile transaction, which closed on April 1, 2017.
Data Processing. Data processing expense increased $1.4 million and $2.9 million, or 113.9% and 80.4%, respectively for the three and nine months ended September 30, 2017 compared to the same periods in 2016. The increase for both periods is reflective of increased costs related directly to the Carlile transaction due to maintaining two core systems until planned conversion in early fourth quarter 2017.
Other real estate impairment. Other real estate impairment increased $866 thousand and $931 thousand, respectively for the three and nine months ended September 30, 2017 primarily due to a $916 thousand writedown on the Houston branch location closed during third quarter 2017, which was transferred from bank premises to other real estate owned.

42





Core Deposit Intangible Amortization. Core deposit intangible amortization increased $917 thousand, or 186.4% and $1.8 million, or 124.9%, respectively for the three and nine months ended September 30, 2017 compared to the same periods in 2016. The increase for both periods reflects the $36.7 million increase in core deposit intangibles recorded with the Carlile transaction.
Professional Fees. Professional fees expense increased $556 thousand and $858 thousand, or 77.5% and 36.4%, respectively for the three and nine months ended September 30, 2017 compared to the same period in 2016. The increase in professional fees is primarily due to increased legal fees on existing litigation and loan workouts inherited in the Carlile transaction in addition to increased consulting fees primarily related to the growth of the Company in various areas such as marketing, human resources, and investment management.
Acquisition Expenses. Acquisition expenses increased $2.4 million, or 80833.3% and increased $7.5 million, or 1026.6%, respectively, for the three and nine months ended September 30, 2017 compared to the same periods in 2016. The increase in acquisition expenses is due to professional fees incurred relating to the acquisition of Carlile as well as a termination fees paid for the cancellation of the contract for Carlile's core processing system and expenses related to restructuring the acquired branch system during third quarter 2017.
Other Noninterest Expense. Other noninterest expense increased $1.9 million and $3.4 million, or 64.1% and 37.5%, respectively for the three and nine months ended September 30, 2017 compared to the same periods in 2016. The increase for both periods is reflective of additional headcount, branch locations and accounts acquired in the Carlile transaction.
Income Tax Expense
Income tax expense was $11.7 million and $27.0 million for the three and nine months ended September 30, 2017, respectively and $7.2 million and $19.2 million for the same periods in 2016. The effective tax rates were 33.2% and 32.0% for the three and nine months ended September 30, 2017, respectively compared to 33.0% and 33.1% for the same periods in 2016. The lower tax rate for the nine months ended 2017 was due to $1.3 million recognized tax benefits related to restricted stock vesting during 2017.

43





Discussion and Analysis of Financial Condition
The following discussion and analysis of the Company’s financial condition discusses and analyzes the financial condition of the Company as of September 30, 2017 and December 31, 2016.
Assets
The Company’s total assets increased by $3.0 billion, or 51.9%, to $8.9 billion as of September 30, 2017 from $5.9 billion at December 31, 2016. The increase is primarily due to $2.4 billion in total assets acquired in the Carlile transaction as well as organic growth for the period.
Loan Portfolio
The following table presents the balance and associated percentage of each major category in our loan portfolio as of September 30, 2017 and December 31, 2016:
 
 
(dollars in thousands)
September 30, 2017
 
December 31, 2016
Commercial (2)
$
1,006,104

 
15.7
%
 
$
630,805

 
13.7
%
Real estate:
 
 
 
 
 
 
 
Commercial
3,255,053

 
50.9

 
2,459,221

 
53.7

Commercial construction, land and land development
710,475

 
11.1

 
531,481

 
11.6

Residential (1)
903,774

 
14.1

 
644,340

 
14.1

Single family interim construction
319,093

 
5.0

 
235,475

 
5.1

Agricultural
156,824

 
2.5

 
53,548

 
1.2

Consumer
39,098

 
0.7

 
27,530

 
0.6

Other
337

 

 
166

 

   
6,390,758

 
100.0
%
 
4,582,566

 
100.0
%
Deferred loan fees
(2,589
)
 
 
 
(2,117
)
 
 
Allowance for loan losses
(37,770
)
 
 
 
(31,591
)
 
 
Total loans, net
$
6,350,399

 
 
 
$
4,548,858

 
 
(1) Includes mortgage loans held for sale as of September 30, 2017 and December 31, 2016 of $25.9 million and $9.8 million, respectively.
(2) Includes mortgage warehouse purchase loans of $138,561 at September 30, 2017.

Our loan portfolio is the largest category of our earning assets. As of September 30, 2017 and December 31, 2016, total loans, net of allowance for loan losses, totaled $6.4 billion and $4.5 billion, respectively, which is an increase of 39.6% between the two dates. The increase is primarily due to $1.4 billion in loans acquired in the Carlile transaction but also due to organic loan growth during 2017.

Asset Quality
Nonperforming Assets. The Company has established procedures to assist the Company in maintaining the overall quality of the Company’s loan portfolio. In addition, the Company has adopted underwriting guidelines to be followed by the Company’s lending officers and which require significant senior management review of proposed extensions of credit exceeding certain thresholds. When delinquencies exist, the Company rigorously monitors the levels of such delinquencies for any negative or adverse trends. The Company’s loan review procedures include approval of lending policies and underwriting guidelines by Independent Bank’s board of directors, an annual independent loan review, approval of large credit relationships by Independent Bank’s Executive Loan Committee and loan quality documentation procedures. The Company, like other financial institutions, is subject to the risk that its loan portfolio will be subject to increasing pressures from deteriorating borrower credit due to general economic conditions.
The Company discontinues accruing interest on a loan when management of the Company believes, after considering the Company’s collection efforts and other factors, that the borrower’s financial condition is such that collection of interest of that loan is doubtful. Loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans, including troubled debt restructurings, that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

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Real estate we have acquired as a result of foreclosure or by deed-in-lieu-of foreclosure is classified as other real estate owned until sold.  The Bank’s policy is to initially record other real estate at fair value less estimated costs to sell at the date of foreclosure.  After foreclosure, other real estate is carried at the lower of the initial carrying amount (fair value less estimated costs to sell or lease), or at the value determined by subsequent appraisals of other real estate.

The Company periodically modifies loans to extend the term or make other concessions to help a borrower with a deteriorating financial condition stay current on their loan and to avoid foreclosure. The Company generally does not forgive principal or interest on loans or modify the interest rates on loans to rates that are below market rates. Under applicable accounting standards, such loan modifications are generally classified as troubled debt restructurings.

The following table sets forth the allocation of the Company’s nonperforming assets among the Company’s different asset categories as of the dates indicated. The Company classifies nonperforming loans (excluding loans acquired with deteriorated credit quality) as nonaccrual loans, loans past due 90 days or more and still accruing interest or loans modified under restructurings as a result of the borrower experiencing financial difficulties. The balances of nonperforming loans reflect the net investment in these assets, including deductions for purchase discounts.
(dollars in thousands)
 
September 30, 2017
 
December 31, 2016
Nonaccrual loans
 
   
 
   
Commercial
 
$
8,254

 
$
7,718

Real estate:
 
 
 
 
Commercial real estate, construction, land and land development
 
1,744

 
5,885

Residential real estate
 
2,389

 
866

Single family interim construction
 

 
884

Consumer
 
237

 
273

Total nonaccrual loans (1)
 
12,624

 
15,626

Loans delinquent 90 days or more and still accruing
 
   

 
   

Commercial
 
16

 

Real estate:
 
   

 
   

Residential real estate
 
16

 

Agricultural
 
9

 

Consumer
 
2

 

Total loans delinquent 90 days or more and still accruing
 
43

 

Troubled debt restructurings, not included in nonaccrual loans
 
   

 
   

Commercial
 

 
1

Real estate:
 
 
 
 
Commercial real estate, construction, land and land development
 
1,067

 
1,204

Residential real estate
 
919

 
1,011

Total troubled debt restructurings, not included in nonaccrual loans
 
1,986

 
2,216

Total nonperforming loans
 
14,653

 
17,842

Other real estate owned and other repossessed assets:
 


 
   

Commercial real estate, construction, land and land development
 
7,970

 
783

Residential Real Estate
 
1,189

 
1,189

Single family interim construction
 
1,030

 

Consumer
 
119

 
4

Total other real estate owned and other repossessed assets
 
10,308

 
1,976

Total nonperforming assets
 
$
24,961

 
$
19,818

Ratio of nonperforming loans to total loans held for investment(2)
 
0.24
%
 
0.39
%
Ratio of nonperforming assets to total assets
 
0.28

 
0.34

(1)  
Nonaccrual loans include troubled debt restructurings of $1.5 million and $209 thousand as of September 30, 2017 and December 31, 2016, respectively and excludes loans acquired with deteriorated credit quality of $10.4 million and $960 thousand as of September 30, 2017 and December 31, 2016, respectively .
(2)  
Excluding mortgage warehouse purchase loans of $138.6 million.

45





Nonaccrual loans decreased to $12.6 million at September 30, 2017 from $15.6 million as of December 31, 2016. Troubled debt restructurings that were not on nonaccrual status totaled $2.0 million at September 30, 2017 decreasing from $2.2 million at December 31, 2016. The decrease in nonaccrual loans was primarily due to the payoffs of two commercial real estate loans totaling $5.8 million, various smaller nonaccrual payoffs, and the foreclosure of a single-family interim construction property totaling $884 thousand offset by five loans totaling $4.0 million that were placed on nonaccrual during the nine months ended September 30, 2017. The net increase in other real estate owned and repossessed assets is primarily due to the addition of the single-family interim construction property foreclosure discussed above as well as the additions of other real estate owned totaling $10.0 million related to the Carlile acquisition and a $1.8 million net addition from the closing of a Houston branch during third quarter 2017 offset by other real estate dispositions totaling $4.9 million during 2017.
As of September 30, 2017, the Company had a total of 97 substandard loans with an aggregate principal balance of $36.5 million that were not currently nonaccrual loans, 90 days past due or more and still accruing, or troubled debt restructurings, but where the Company had information about possible credit problems of the borrowers that caused the Company’s management to have serious concerns as to the ability of the borrowers to comply with present loan repayment terms and that could result in those loans becoming nonaccrual loans, 90 days past due or more and still accruing, or troubled debt restructurings in the future.
The Company generally continues to use the classification of acquired loans classified nonaccrual or 90 days and accruing as of the acquisition date. The Company does not classify acquired loans as troubled debt restructurings, or TDRs, unless the Company modifies an acquired loan subsequent to acquisition that meets the TDR criteria. Reported delinquency of the Company’s purchased loan portfolio is based upon the contractual terms of the loans.
Allowance for Loan Losses. The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The Company’s allowance for loan losses represents the Company’s estimate of probable and reasonably estimable loan losses inherent in loans held for investment as of the respective balance sheet date. The Company’s methodology for assessing the adequacy of the allowance for loan losses includes a general allowance for performing loans, which are grouped based on similar characteristics, and an allocated allowance for individual impaired loans. Actual credit losses or recoveries are charged or credited directly to the allowance. As of September 30, 2017, the allowance for loan losses amounted to $37.8 million, or 0.61% of total loans, compared with $31.6 million, or 0.69% of total loans as of December 31, 2016. The dollar increases from prior periods are primarily due to additional general reserves for organic loan growth. The decrease in the allowance for loan losses as a percentage of loans reflects that loans acquired in the Carlile transaction were recorded at fair value without a reserve at acquisition date. As of September 30, 2017, the discount on acquired loans totaled $28.6 million.
The allowance for loan losses to nonperforming loans has increased from 177.06% at December 31, 2016 to 257.76% at September 30, 2017. Nonperforming loans have decreased to $14.7 million at September 30, 2017 compared to $17.8 million at December 31, 2016 primarily due to the payoff of two commercial real estate loans and the foreclosure of a single-family interim construction property, offset by the nonaccrual loan additions as discussed above.


Securities Available for Sale
The Company’s investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit, interest rate and duration risk. The types and maturities of securities purchased are primarily based on the Company’s current and projected liquidity and interest rate sensitivity positions.
The Company recognized a net gain of $52 thousand on the sale of securities for the nine months ended September 30, 2017 and a gain of $4 thousand on the sale of securities during the nine months ended September 30, 2016. Securities represented 8.4% and 5.4% of the Company’s total assets at September 30, 2017 and December 31, 2016, respectively.
Management evaluates securities for other-than-temporary impairment (OTTI) on at least a quarterly basis and more frequently when economic of market conditions warrant such an evaluation. Management does not intend to sell any debt securities it holds and believes the Company more likely than not will not be required to sell any debt securities it holds before their anticipated recovery, at which time the Company will receive full value for the securities. Management has the ability and intent to hold the securities classified as available for sale that were in a loss position as of September 30, 2017 for a period of time sufficient for an entire recovery of the cost basis of the securities. For those securities that are impaired, the unrealized losses are largely due to interest rate changes. The fair value is expected to recover as the securities approach their maturity date. Management believes any impairment in the Company’s securities at September 30, 2017 is temporary and no other-than-temporary impairment has been realized in the Company’s consolidated financial statements.

46





Capital Resources and Regulatory Capital Requirements

Total stockholder’s equity was $1.3 billion at September 30, 2017 compared with $672.4 million at December 31, 2016, an increase of approximately $609.1 million. The majority of the increase was due to stock issued in the Carlile acquisition for a total, net of offering costs, of $551.2 million as well as net income of $57.3 million earned by the Company during the nine months ended September 30, 2017, stock based compensation of $3.4 million and an increase of $4.6 million in unrealized gain on available for sale securities offset by dividends paid of $7.5 million.
 
As of September 30, 2017, the Company exceeded all capital ratio requirements under prompt corrective action and other regulatory requirements, as detailed in the table below:   
 
As of September 30, 2017
 
Actual
Required to be considered well capitalized
Required to be considered adequately capitalized
 
Ratio
Ratio
Ratio
Tier 1 capital to average assets ratio
8.30
%
≥5.00%
4.00-5.00%
Common equity tier 1 capital to risk-weighted assets ratio
9.17

≥6.50
4.50-6.50
Tier 1 capital to risk-weighted assets ratio
9.60

≥8.00
6.00-8.00
Total capital to risk-weighted assets ratio
11.72

≥10.00
8.00-10.00
Liquidity Management
The Company continuously monitors the Company’s liquidity position to ensure that assets and liabilities are managed in a manner that will meet all of the Company’s short-term and long-term cash requirements. The Company manages the Company’s liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of the Company’s shareholders. The Company also monitors its liquidity requirements in light of interest rate trends, changes in the economy, and the scheduled maturity and interest rate sensitivity of the investment and loan portfolios and deposits.
Liquidity risk management is an important element in the Company’s asset/liability management process. The Company’s short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of pre-paid and maturing balances in the Company’s loan and investment portfolios, debt financing and increases in customer deposits. The Company’s liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest-bearing deposits in banks, federal funds sold, securities available for sale and maturing or prepaying balances in the Company’s investment and loan portfolios. Liquid liabilities include core deposits, brokered deposits, federal funds purchased, securities sold under repurchase agreements and other borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market non core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, borrowings through the Federal Reserve’s discount window and the issuance of equity securities. For additional information regarding the Company’s operating, investing and financing cash flows, see the Consolidated Statements of Cash Flows provided in the Company’s consolidated financial statements.
In addition to the liquidity provided by the sources described above, Independent Bank maintains correspondent relationships with other banks in order to sell loans or purchase overnight funds should additional liquidity be needed. As of September 30, 2017, the Bank had established federal funds lines of credit with nine unaffiliated banks totaling $270.0 million with no amounts advanced against those lines at that time. The Company also participates with an exchange that provides direct overnight borrowings with other financial institutions with a borrowing capacity of $79 million and none outstanding as of September 30, 2017. The Company has an unsecured line of credit totaling $50.0 million at two unaffiliated commercial banks that was subsequently amended on October 20, 2017 with only one of the commercial banks. Based on the values of stock, securities, and loans pledged as collateral, as of September 30, 2017, the Company had additional borrowing capacity with the FHLB of $1.6 billion. In addition, the Company maintains a secured line of credit with the Federal Reserve Bank with an availability to borrow $607.6 million.

47





Contractual Obligations
In the ordinary course of the Company’s operations, the Company enters into certain contractual obligations, such as obligations for operating leases and other arrangements with respect to deposit liabilities, FHLB advances and other borrowed funds. The Company believes that it will be able to meet its contractual obligations as they come due through the maintenance of adequate cash levels. The Company expects to maintain adequate cash levels through profitability, loan and securities repayment and maturity activity and continued deposit gathering activities. The Company has in place various borrowing mechanisms for both short-term and long-term liquidity needs.
During the nine months ended September 30, 2017, the Company acquired deposit accounts, repurchase agreements and junior subordinated debentures in the Carlile transaction. In addition, the Company assumed operating lease commitments for several branch locations acquired. Other than acquired accounts and normal changes in the ordinary course of business, there have been no significant changes in the types of contractual obligations or amounts due since December 31, 2016.
Off-Balance Sheet Arrangements
In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in the Company’s consolidated balance sheets. However, the Company has only limited off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. Independent Bank enters into these transactions to meet the financing needs of the Company’s customers. These transactions include commitments to extend credit and issue standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.
Commitments to Extend Credit. Independent Bank enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of Independent Bank’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Independent Bank minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.
Standby Letters of Credit. Standby letters of credit are written conditional commitments that Independent Bank issues to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, Independent Bank would be required to fund the commitment. The maximum potential amount of future payments Independent Bank could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the customer is obligated to reimburse Independent Bank for the amount paid under this standby letter of credit.
Independent Bank’s commitments to extend credit and outstanding standby letters of credit were $1.1 billion and $8.6 million, respectively, as of September 30, 2017. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements. The Company manages the Company’s liquidity in light of the aggregate amounts of commitments to extend credit and outstanding standby letters of credit in effect from time to time to ensure that the Company will have adequate sources of liquidity to fund such commitments and honor drafts under such letters of credit.
Critical Accounting Policies and Estimates
The preparation of the Company’s consolidated financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires the Company to make estimates and judgments that affect the Company’s reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. The Company evaluates the Company’s estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.



48





Accounting policies, as described in detail in the notes to the Company’s consolidated financial statements, are an integral part of the Company’s financial statements. A thorough understanding of these accounting policies is essential when reviewing the Company’s reported results of operations and the Company’s financial position. The Company believes that the critical accounting policies and estimates discussed below require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain. Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, would have a material impact on the Company’s financial position, results of operations or liquidity.
Acquired Loans. The Company’s accounting policies require that the Company evaluates all acquired loans for evidence of deterioration in credit quality since origination and to evaluate whether it is probable that the Company will collect all contractually required payments from the borrower.
Acquired loans from the transactions accounted for as a business combination include both loans with evidence of credit deterioration since their origination date and performing loans. The Company accounts for performing loans under ASC Paragraph 310-20, Nonrefundable Fees and Other Costs, with the related discount being adjusted for over the life of the loan and recognized as interest income. The Company accounts for the loans acquired in accordance with ASC Paragraph 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. At the date of the acquisition, acquired loans are recorded at their fair value.
The Company recognizes the difference between the undiscounted cash flows the Company expects (at the time the Company acquires the loan) to be collected and the investment in the loan, or the “accretable yield,” as interest income using the interest method over the life of the loan. The Company does not recognize contractually required payments for interest and principal that exceed undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” as a yield adjustment, loss accrual or valuation allowance. Increases in the expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over the loan’s remaining life, while decreases in expected cash flows are recognized as impairment. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition.
Upon an acquisition, the Company generally continues to use the classification of acquired loans classified nonaccrual or 90 days and accruing. The Company does not classify acquired loans as TDRs unless the Company modifies an acquired loan subsequent to acquisition that meets the TDR criteria. Reported delinquency of the Company’s purchased loan portfolio is based upon the contractual terms of the loans.
Allowance for Loan Losses. The allowance for loan losses represents management’s estimate of probable and reasonably estimable credit losses inherent in the loan portfolio. In determining the allowance, the Company estimates losses on individual impaired loans, or groups of loans which are not impaired, where the probable loss can be identified and reasonably estimated. On a quarterly basis, the Company assesses the risk inherent in the Company’s loan portfolio based on qualitative and quantitative trends in the portfolio, including the internal risk classification of loans, historical loss rates, changes in the nature and volume of the loan portfolio, industry or borrower concentrations, delinquency trends, detailed reviews of significant loans with identified weaknesses and the impacts of local, regional and national economic factors on the quality of the loan portfolio. Based on this analysis, the Company records a provision for loan losses in order to maintain the allowance at appropriate levels.
Determining the amount of the allowance is considered a critical accounting estimate, as it requires significant judgment and the use of subjective measurements, including management’s assessment of overall portfolio quality. The Company maintains the allowance at an amount the Company believes is sufficient to provide for estimated losses inherent in the Company’s loan portfolio at each balance sheet date, and fluctuations in the provision for loan losses may result from management’s assessment of the adequacy of the allowance. Changes in these estimates and assumptions are possible and may have a material impact on the Company’s allowance, and therefore the Company’s financial position, liquidity or results of operations.






49





Goodwill and Core Deposit Intangible. The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely an impairment has occurred. Under current accounting standards, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, no further testing is necessary. If the Company concludes otherwise, then it is required to perform the first step of the two step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. The Company performs its impairment test annually as of December 31. There have been no circumstances since December 31, 2016 that would indicate any impairment has occurred, therefore, management does not believe goodwill is impaired as of September 30, 2017.
Core deposit intangibles are acquired customer relationships that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. Core deposit intangibles are being amortized on a straight-line basis over their estimated useful lives of ten years. Core deposit intangibles are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.


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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The principal objective of the Company’s asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing net income and preserving adequate levels of liquidity and capital. The Investment Committee of the Bank’s Board of Directors has oversight of our asset and liability management function, which is managed by our Treasurer. Our Treasurer meets with our Chief Financial Officer and senior executive management team regularly to review, among other things, the sensitivity of the Company’s assets and liabilities to market interest rate changes, local and national market conditions and market interest rates. That group also reviews the liquidity, capital, deposit mix, loan mix and investment positions of our Company.
Our management and our Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit our exposure to interest rate risk. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans, securities and deposits, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows.
Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.
We also analyze the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to our future earnings and is used in conjunction with the analyses on net interest income.
We conduct periodic analyses of our sensitivity to interest rate risks through the use of a third-party proprietary interest-rate sensitivity model. That model has been customized to our specifications on an installment level basis. The analyses conducted by use of that model are based on current information regarding our actual interest-earnings assets, interest-bearing liabilities, capital and other financial information that we supply. The third party uses that information in the model to estimate our sensitivity to interest rate risk.
Our interest rate risk model indicated that we were in a slightly asset sensitive position as of September 30, 2017. The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase and a 100 basis point decrease in interest rates on net interest income based on the interest rate risk model as of September 30, 2017:
   
Hypothetical Shift in
Interest Rates (in bps)
% Change in Projected
Net Interest Income
200
1.54%
100
0.57%
(100)
1.79%

These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each period-end and is based on future maturities and market pricing over the relevant twelve month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities re-price in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.


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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q was performed under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms.
Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting during the three months ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.



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PART II

Item 1. LEGAL PROCEEDINGS
In the normal course of business, the Company and Independent Bank are named as defendants in various lawsuits. Management of the Company and Independent Bank, following consultation with legal counsel, do not expect the ultimate disposition of any, or a combination, of these matters to have a material adverse effect on the business of the Company or Independent Bank. A legal proceeding that the Company believes could become material is described below.

Independent Bank is a party to a legal proceeding inherited by Independent Bank in connection with the Company's acquisition of BOH Holdings, Inc. and its subsidiary, Bank of Houston, or BOH, that was completed on April 15, 2014. Several entities related to R. A. Stanford, or the Stanford Entities, including Stanford International Bank, Ltd., or SIBL, had deposit accounts at BOH. Certain individuals who had purchased certificates of deposit from SIBL filed a class action lawsuit against several banks, including BOH, on November 11, 2009 in the U.S. District Court Northern District of Texas, Dallas Division, alleging, among other things, that the plaintiffs were victims of fraud by SIBL and other Stanford Entities and seeking to recover damages and alleged fraudulent transfers by the defendant banks.

On May 1, 2015, the plaintiffs filed a motion requesting permission to file a Second Amended Class Action Complaint in this case, which motion was subsequently granted. The Second Amended Class Action Complaint asserted previously unasserted claims, including aiding and abetting or participation in a fraudulent scheme based upon the large amount of deposits that the Stanford Entities held at BOH and the alleged knowledge of certain BOH officers. Given the new allegations, Independent Bank notified its insurance carriers of the claims made in the Second Amended Class Action Complaint. The insurance carriers have initially indicated that a “loss” has not yet occurred or that the claims are not covered by the policies. However, Independent Bank is continuing to pursue insurance coverage for these claims, as well as for the reimbursement of defense costs, through the initiation of litigation and other means.

Independent Bank believes that the claims made in this lawsuit are without merit and is vigorously defending this lawsuit. This is complex litigation involving a number of procedural matters and issues. As such, Independent Bank is unable to predict when this matter may be resolved and, given the uncertainty of litigation, the ultimate outcome of, or potential costs or damages arising from, this case.

Item 1A. RISK FACTORS

In evaluating an investment in our securities, investors should consider carefully, among other things, the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, in the information contained in this Quarterly Report on Form 10-Q and our other reports and registrations statements, and, with respect to our 5.875% Subordinated Notes due August 1, 2024, in the Prospectus Supplement filed pursuant to Rule 424(b)(5) on June 23, 2016, in each case as filed with the SEC. In addition to the risk factors disclosed in those reports and registrations, you should note the following risk factor:

Catastrophic weather events can have an adverse impact on the Company’s business, financial condition and operations.

Hurricanes, tornadoes, wildfires, earthquakes and other natural disasters and severe weather events have caused, and in the future may cause, widespread property damage and significantly and negatively affect the local economies in which the Company operates. For example, in late August 2017, Hurricane Harvey, a Category 4 hurricane, caused catastrophic flooding and unprecedented damage to residences and businesses across Southeast Texas, including Houston. The Company currently operates 10 banking centers in the greater Houston area. The effect of Hurricane Harvey, and other catastrophic weather events if they were to occur, could have a materially adverse impact on the Company’s financial condition, results of operations and business, as well as potentially increase the Company’s exposure to credit losses and liquidity risks.


Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None


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Item 3. DEFAULTS UPON SENIOR SECURITIES

None

Item 4. MINE SAFETY DISCLOSURES

Not applicable

Item 5. OTHER INFORMATION

None


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Item 6. EXHIBITS
The following documents are filed as exhibits to this Quarterly Report on Form 10-Q:
   
 
 
 
Exhibit 3.1
   
   
   
Exhibit 3.2
   
   
   
Exhibit 3.3
   
   
   
Exhibit 3.4
 

 
 
 
Exhibit 3.5
 

 
 
 
Exhibit 3.6

 

 
 
 
Exhibit 3.7
 

 
 
 
Exhibit 3.8
 

 
 
 
Exhibit 4.1

 

 
 
 
Exhibit 4.2

 
 
 
 
Exhibit 4.3

 
 
 
 
Exhibit 4.4

 
 
 
 
Exhibit 4.5*
 
 
 
 
Exhibit 4.6

 
 
 
 

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Exhibit 4.7
 
 
 
 
The other instruments defining the rights of holders of the long-term debt securities of the Registrant and its subsidiaries are omitted pursuant to section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Registrant hereby agrees to furnish copies of these instruments to the SEC upon request.

Exhibit 31.1*
   
   
   
Exhibit 31.2*
   
   
   
Exhibit 32.1**
   
   
   
Exhibit 32.2**
   
 
 
Exhibit 101.INS *
   
XBRL Instance Document
   
   
Exhibit 101.SCH *
   
XBRL Taxonomy Extension Schema Document
   
   
Exhibit 101.CAL *
   
XBRL Taxonomy Extension Calculation Linkbase Document
   
   
Exhibit 101.DEF *
   
XBRL Taxonomy Extension Definition Linkbase Document
   
   
Exhibit 101.LAB *
   
XBRL Taxonomy Extension Label Linkbase Document
   
   
Exhibit 101.PRE *
   
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
*
Filed herewith as an Exhibit.
**
Furnished herewith as an Exhibit.


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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
   
   
   
Independent Bank Group, Inc.
   
   
   
Date: October 26, 2017
   
By: /s/ David R. Brooks
   
   
   
   
   
David R. Brooks
   
   
Chairman, Chief Executive Officer and President
   
Date: October 26, 2017
   
By: /s/ Michelle S. Hickox
   
   
   
   
   
Michelle S. Hickox
   
   
Executive Vice President
   
   
Chief Financial Officer


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