Independent Bank Group, Inc. - Quarter Report: 2019 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



☒	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended June 30, 2019.



☐	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.)

7777 Henneman Way
McKinney,
Texas		75070-1711
(Address of principal executive offices)		(Zip Code)

(972) 562-9004

(Registrant’s telephone number, including area code)



1600 Redbud Boulevard, Suite 400
McKinney,	Texas	75069-3257

(Former name, former address and former fiscal year, if changed since last report)

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



Title of Each Class	Trading Symbol(s)	Name of Exchange on Which Registered
Common Stock, par value $0.01 per share	IBTX	NASDAQ Global Select Market

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 ☒ 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 ☒ 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	☐
Non-Accelerated Filer	☐	(Do not check if a smaller reporting company)
			Smaller Reporting Company	☐
			Emerging Growth Company	☐

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

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

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 – 42,949,401 shares as of July 23, 2019.

INDEPENDENT BANK GROUP, INC. AND SUBSIDIARIES

Form 10-Q

June 30, 2019



PART I.	Financial Information

Item 1.	Financial Statements
	Consolidated Balance Sheets-Unaudited	1
	Consolidated Statements of Income-Unaudited	2
	Consolidated Statements of Comprehensive Income-Unaudited	3
	Consolidated Statements of Changes in Stockholders’ Equity-Unaudited	4
	Consolidated Statements of Cash Flows-Unaudited	5
	Notes to Consolidated Financial Statements-Unaudited	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	57

Item 4.	Controls and Procedures	58

PART II.	Other Information

Item 1.	Legal Proceedings	58

Item 1A.	Risk Factors	59

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	59

Item 3.	Defaults Upon Senior Securities	59

Item 4.	Mine Safety Disclosures	59

Item 5.	Other Information	59

Item 6.	Exhibits	60

Signatures

***

Table of Contents

Independent Bank Group, Inc. and Subsidiaries

Consolidated Balance Sheets

June 30, 2019 (unaudited) and December 31, 2018

(Dollars in thousands, except share information)



	June 30,		December 31,
Assets	2019		2018
Cash and due from banks	$	141,310	$	102,024
Interest-bearing deposits in other banks	438,137		28,755
Cash and cash equivalents	579,447		130,779
Certificates of deposit held in other banks	5,216		1,225
Securities available for sale, at fair value	1,104,520		685,350
Loans held for sale (includes $17,988 and $27,871 carried at fair value, respectively)	106,489		32,727
Loans, net	11,183,877		7,839,695
Premises and equipment, net	244,523		167,866
Other real estate owned	10,972		4,200
Federal Home Loan Bank (FHLB) of Dallas stock and other restricted stock	33,346		26,870
Bank-owned life insurance (BOLI)	212,704		129,521
Deferred tax asset	13,189		13,180
Goodwill	994,097		721,797
Other intangible assets, net	110,090		45,042
Other assets	110,452		51,713
Total assets	$	14,708,922	$	9,849,965

Liabilities and Stockholders’ Equity
Deposits:
Noninterest-bearing	$	3,153,001	$	2,145,930
Interest-bearing	8,377,586		5,591,864
Total deposits	11,530,587		7,737,794
FHLB advances	580,000		290,000
Other borrowings	212,534		137,316
Junior subordinated debentures	53,725		27,852
Other liabilities	82,734		50,570
Total liabilities	12,459,580		8,243,532
Commitments and contingencies
Stockholders’ equity:
Preferred stock (0 and 0 shares outstanding, respectively)	—		—
Common stock (42,953,818 and 30,600,582 shares outstanding, respectively)	430		306
Additional paid-in capital	1,922,475		1,317,616
Retained earnings	309,314		296,816
Accumulated other comprehensive income (loss)	17,123		(8,305		)
Total stockholders’ equity	2,249,342		1,606,433
Total liabilities and stockholders’ equity	$	14,708,922	$	9,849,965

See Notes to Consolidated Financial Statements

Table of Contents

Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Income

Three and Six Months Ended June 30, 2019 and 2018 (unaudited)

(Dollars in thousands, except per share information)



	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Interest income:
Interest and fees on loans	$	157,431		$	91,614		$	302,962		$	174,889
Interest on taxable securities	5,277			3,501			10,727			6,404
Interest on nontaxable securities	2,127			1,179			4,352			2,372
Interest on interest-bearing deposits and other	2,828			788			5,198			1,531
Total interest income	167,663			97,082			323,239			185,196
Interest expense:
Interest on deposits	31,322			12,827			59,164			22,626
Interest on FHLB advances	2,984			2,847			5,594			4,733
Interest on other borrowings and repurchase agreements	2,923			2,097			5,638			4,199
Interest on junior subordinated debentures	791			402			1,548			762
Total interest expense	38,020			18,173			71,944			32,320
Net interest income	129,643			78,909			251,295			152,876
Provision for loan losses	4,739			2,730			7,963			5,425
Net interest income after provision for loan losses	124,904			76,179			243,332			147,451
Noninterest income:
Service charges on deposit accounts	6,164			3,533			12,074			7,018
Investment management and trust	2,522			—			4,741			—
Mortgage banking revenue	3,702			3,609			6,795			7,023
Gain on sale of other real estate	312			58			312			118
Gain (loss) on sale of securities available for sale	20			(10		)	265			(234		)
Loss on sale of premises and equipment	(279		)	(89		)	(270		)	(97		)
Increase in cash surrender value of BOLI	1,374			758			2,733			1,497
Other	2,384			2,274			5,973			4,263
Total noninterest income	16,199			10,133			32,623			19,588
Noninterest expense:
Salaries and employee benefits	40,532			26,790			82,912			51,958
Occupancy	9,585			6,018			18,576			11,682
Data processing	4,449			2,467			8,218			4,872
FDIC assessment	962			712			2,210			1,453
Advertising and public relations	812			332			1,475			717
Communications	1,327			793			2,622			1,734
Other real estate owned expenses, net	79			119			150			209
Impairment of other real estate	988			—			1,424			85
Amortization of other intangible assets	3,235			1,393			6,470			2,724
Professional fees	1,544			1,133			2,714			2,252
Acquisition expense, including legal	3,723			3,444			18,710			3,989
Other	10,742			5,957			19,092			12,441
Total noninterest expense	77,978			49,158			164,573			94,116
Income before taxes	63,125			37,154			111,382			72,923
Income tax expense	13,389			7,519			24,515			14,324
Net income	$	49,736		$	29,635		$	86,867		$	58,599
Basic earnings per share	$	1.15		$	1.02		$	1.99		$	2.04
Diluted earnings per share	$	1.15		$	1.02		$	1.99		$	2.04

See Notes to Consolidated Financial Statements

Table of Contents

Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

Three and Six Months Ended June 30, 2019 and 2018 (unaudited)

(Dollars in thousands)



	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Net income	$	49,736		$	29,635		$	86,867		$	58,599
Other comprehensive income (loss) before tax:
Change in net unrealized gains (losses) on available for sale securities during the year	17,645			(1,264		)	32,796			(12,179		)
Reclassification for amount realized through sales of securities available for sale included in net income	(20		)	10			(265		)	234
Other comprehensive income (loss) before tax	17,625			(1,254		)	32,531			(11,945		)
Income tax expense (benefit)	3,973			(263		)	7,103			(2,508		)
Other comprehensive income (loss), net of tax	13,652			(991		)	25,428			(9,437		)
Comprehensive income	$	63,388		$	28,644		$	112,295		$	49,162

See Notes to Consolidated Financial Statements

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Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Six Months Ended June 30, 2019 and 2018 (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
	Preferred Stock $.01 Par Value 10 million shares authorized		Shares		Amount			Additional Paid in Capital			Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Total
Balance, December 31, 2018	$	—	30,600,582		$	306		$	1,317,616		$	296,816		$	(8,305	)	$	1,606,433
Cumulative effect of change in accounting principles	—		—		—			—			(926		)	—			(926		)
Net income	—		—		—			—			37,131			—			37,131
Other comprehensive income, net of tax	—		—		—			—			—			11,776			11,776
Stock issued for acquisition of bank, net of offering costs of $804	—		13,179,748		132			600,936			—			—			601,068
Common stock repurchased	—		(225,903	)	(2		)	—			(12,505		)	—			(12,507		)
Restricted stock forfeited	—		(385	)	—			—			—			—			—
Restricted stock granted	—		111,751		1			(1		)	—			—			—
Stock based compensation expense	—		—		—			2,172			—			—			2,172
Cash dividends ($0.25 per share)	—		—		—			—			(10,945		)	—			(10,945		)
Balance, March 31, 2019	$	—	43,665,793		$	437		$	1,920,723		$	309,571		$	3,471		$	2,234,202
Net income	—		—		—			—			49,736			—			49,736
Other comprehensive income, net of tax	—		—		—			—			—			13,652			13,652
Common stock repurchased	—		(726,002	)	(7		)	—			(39,096		)	—			(39,103		)
Restricted stock forfeited	—		(7,833	)	—			—			—			—			—
Restricted stock granted	—		21,860		—			—			—			—			—
Stock based compensation expense	—		—		—			1,752			—			—			1,752
Cash dividends ($0.25 per share)	—		—		—			—			(10,897		)	—			(10,897		)
Balance, June 30, 2019	$	—	42,953,818		$	430		$	1,922,475		$	309,314		$	17,123		$	2,249,342

Balance, December 31, 2017	$	—	28,254,893		$	283		$	1,151,990		$	184,232		$	(487	)	$	1,336,018
Cumulative effect of change in accounting principle	—		—		—			—			233			(233		)	—
Net income	—		—		—			—			28,964			—			28,964
Other comprehensive loss, net of tax	—		—		—			—			—			(8,446		)	(8,446		)
Restricted stock forfeited	—		(606	)	—			—			—			—			—
Restricted stock granted	—		99,812		1			(1		)	—			—			—
Stock based compensation expense	—		—		—			1,412			—			—			1,412
Exercise of warrants	—		8,874		—			152			—			—			152
Cash dividends ($0.12 per share)	—		—		—			—			(3,401		)	—			(3,401		)
Balance, March 31, 2018	$	—	28,362,973		$	284		$	1,153,553		$	210,028		$	(9,166	)	$	1,354,699
Net income	—		—		—			—			29,635			—			29,635
Other comprehensive loss, net of tax	—		—		—			—			—			(991		)	(991		)
Stock issued for acquisition of bank, net of offering costs of $209	—		2,071,981		21			157,033			—			—			157,054
Restricted stock forfeited	—		(3,239	)	—			—			—			—			—
Restricted stock granted	—		19,100		—			—			—			—			—
Stock based compensation expense	—		—		—			1,543			—			—			1,543
Exercise of warrants	—		17,598		—			303			—			—			303
Cash dividends ($0.14 per share)	—		—		—			—			(3,974		)	—			(3,974		)
Balance, June 30, 2018	$	—	30,468,413		$	305		$	1,312,432		$	235,689		$	(10,157	)	$	1,538,269

See Notes to Consolidated Financial Statements

Table of Contents

Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Six Months Ended June 30, 2019 and 2018 (unaudited)

(Dollars in thousands)



	Six Months Ended June 30,
	2019			2018
Cash flows from operating activities:
Net income	$	86,867		$	58,599
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense	5,642			4,129
Accretion of income recognized on acquired loans	(25,348		)	(6,177		)
Amortization of other intangibles assets	6,470			2,724
Amortization of premium on securities, net	1,497			2,037
Amortization of discount and origination costs on borrowings	317			315
Stock based compensation expense	3,924			2,955
Excess tax expense (benefit) on restricted stock vested	10			(613		)
FHLB stock dividends	(406		)	(318		)
(Gain) loss on sale of securities available for sale	(265		)	234
Loss on sale of premises and equipment	270			97
Gain on sale of other real estate owned	(312		)	(118		)
Impairment of other real estate	1,424			85
Deferred tax expense	8,515			770
Provision for loan losses	7,963			5,425
Increase in cash surrender value of BOLI	(2,733		)	(1,497		)
Net gain on loans held for sale	(6,374		)	(6,564		)
Originations of loans held for sale	(175,388		)	(206,814		)
Proceeds from sale of loans held for sale	191,526			222,524
Net change in other assets	(7,521		)	(1,074		)
Net change in other liabilities	(18,182		)	(141		)
Net cash provided by operating activities	77,896			76,578
Cash flows from investing activities:
Proceeds from maturities, calls and pay downs of securities available for sale	3,615,292			1,060,297
Proceeds from sale of securities available for sale	189,704			27,473
Purchases of securities available for sale	(3,632,697		)	(1,105,323		)
Purchases of certificates of deposit held in other banks	(4,954		)	—
Proceeds from maturities of certificates of deposit held in other banks	1,225			11,760
Proceeds from surrender of bank owned life insurance contracts	387			—
Purchase of bank owned life insurance contracts	—			(5,000		)
Purchases of FHLB stock and other restricted stock	(8,622		)	(6,144		)
Proceeds from redemptions of FHLB stock and other restricted stock	30,346			—
Net loans originated held for investment	(337,280		)	(513,801		)
Originations of mortgage warehouse purchase loans	(4,560,698		)	(2,528,326		)
Proceeds from pay-offs of mortgage warehouse purchase loans	4,277,496			2,528,230
Additions to premises and equipment	(26,286		)	(9,937		)
Proceeds from sale of premises and equipment	1,607			3,139
Proceeds from sale of other real estate owned	1,749			2,959
Cash received from acquired bank	39,913			44,723
Cash paid in connection with acquisition	(9		)	(31,016		)
Net cash used in investing activities	(412,827		)	(520,966		)

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Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (Continued)

Six Months Ended June 30, 2019 and 2018 (unaudited)

(Dollars in thousands)



	Six Months Ended June 30,
	2019			2018
Cash flows from financing activities:
Net increase in demand deposits, money market and savings accounts	381,193			240,738
Net increase in time deposits	294,315			66,767
Proceeds from FHLB advances	1,300,000			960,000
Repayments of FHLB advances	(1,152,653		)	(800,041		)
Proceeds from other borrowings	56,000			—
Repayments of other borrowings	(21,000		)	—
Proceeds from exercise of common stock warrants	—			455
Repurchase of common stock	(51,610		)	—
Offering costs paid in connection with acquired bank	(804		)	(209		)
Dividends paid	(21,842		)	(7,375		)
Net cash provided by financing activities	783,599			460,335
Net change in cash and cash equivalents	448,668			15,947
Cash and cash equivalents at beginning of year	130,779			431,102
Cash and cash equivalents at end of year	$	579,447		$	447,049

See Notes to Consolidated Financial Statements

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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 Southeast, 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 and all other entities in which IBG has controlling financial interest. All material intercompany transactions and balances have been eliminated in consolidation. In addition, the Company wholly-owns nine statutory business trusts that were formed for the purpose of issuing trust preferred securities and do not meet the criteria for consolidation.

On January 1, 2019, the Company acquired Guaranty Bancorp (Guaranty) and its wholly owned subsidiary, Guaranty Bank and Trust Company (Guaranty Bank) and its wholly owned subsidiary, Private Capital Management, LLC. Guaranty has been merged into the Company and dissolved and Guaranty Bank and its subsidiary has been merged with the Bank as of acquisition date. The Company also acquired two statutory business trusts in connection with the acquisition as disclosed in Note 5, Other Borrowings and Junior Subordinated Debentures. See Note 13, Business Combinations, for more details of the Guaranty acquisition.

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 on Form10-K for the year ended December 31, 2018. The consolidated balance sheet at December 31, 2018 has 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.

Reclassifications: Certain prior period financial statement amounts have been reclassified to conform to current period presentation. The reclassifications have no effect on net income or stockholders' equity as previously reported.

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 14.

Share repurchase program: The Company established share repurchase programs in prior years which would allow the Company to purchase its common stock in the open market or in privately negotiated transactions. In general, share repurchase programs allow the Company to proactively manage its capital position and return excess capital to shareholders. On October 24, 2018, the Company announced the reestablishment of its share repurchase program. The program authorizes the Company to repurchase up to $75,000 of its common stock. The repurchase program is authorized to continue through October 1, 2019. As of June 30, 2019, the Company has repurchased a total of 897,738 shares of Company stock at a total cost of $49,048 under this program. Shares of Company stock repurchased to settle employee tax withholding related to vesting of stock awards during the period ended June 30, 2019 totaled 54,167 at a total cost of $2,562 and were not included under this program.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

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 six months ended June 30, 2019 and 2018. Proceeds from the assumed exercise of dilutive stock warrants are assumed to be used to repurchase common stock at the average market price. All stock warrants were exercised during 2018.

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 June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Basic earnings per share:
Net income	$	49,736	$	29,635	$	86,867	$	58,599
Less:
Undistributed earnings allocated to participating securities	286		221		435		465
Dividends paid on participating securities	80		35		146		68
Net income available to common shareholders	$	49,370	$	29,379	$	86,286	$	58,066
Weighted average basic shares outstanding	43,013,343		28,814,759		43,253,072		28,434,002
Basic earnings per share	$	1.15	$	1.02	$	1.99	$	2.04
Diluted earnings per share:
Net income available to common shareholders	$	49,370	$	29,379	$	86,286	$	58,066
Total weighted average basic shares outstanding	43,013,343		28,814,759		43,253,072		28,434,002
Add dilutive stock warrants	—		92,392		—		92,187
Total weighted average diluted shares outstanding	43,013,343		28,907,151		43,253,072		28,526,189
Diluted earnings per share	$	1.15	$	1.02	$	1.99	$	2.04
Anti-dilutive participating securities	31,382		63,003		47,511		111,538

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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:



	Six Months Ended June 30,
	2019		2018
Cash transactions:
Interest expense paid	$	67,019	$	31,410
Income taxes paid	$	12,918	$	9,009
Noncash transactions:
Transfers of loans to other real estate owned	$	544	$	—
Transfers of loans held for investment to loans held for sale	$	83,526	$	—
Loans to facilitate the sale of other real estate owned	$	517	$	—
Right-of-use assets obtained in exchange for lease liabilities	$	34,790	$	—
Transfer of bank premises to other real estate	$	7,896	$	—
Transfer of repurchase agreements to deposits	$	8,475	$	—

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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:



	Six Months Ended June 30,
	2019		2018
Noncash assets acquired
Certificates of deposit held in other banks	$	262	$	—
Securities available for sale	561,052		24,726
Restricted stock	27,794		3,357
Loans	2,789,868		651,722
Premises and equipment	65,786		4,800
Other real estate owned	1,710		—
Goodwill	272,300		100,120
Other intangible assets	71,518		7,532
Bank owned life insurance	80,837		8,181
Other assets	32,009		6,416
Total assets	$	3,903,136	$	806,854
Noncash liabilities assumed:
Deposits	$	3,108,810	$	593,078
Repurchase agreements	8,475		—
FHLB advances	142,653		60,000
Other borrowings	40,000		—
Junior subordinated debentures	25,774		—
Other liabilities	15,456		10,220
Total liabilities	$	3,341,168	$	663,298
Cash and cash equivalents acquired from acquisitions	$	39,913	$	44,723
Cash paid to shareholders of acquired banks	$	9	$	31,016
Fair value of common stock issued to shareholders of acquired banks	$	601,872	$	157,263

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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 June 30, 2019 and December 31, 2018, are as follows:



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Securities Available for Sale
June 30, 2019
U.S. treasuries	$	50,060	$	808	$	(35	)	$	50,833
Government agency securities	186,839		1,212		(190		)	187,861
Obligations of state and municipal subdivisions	347,020		9,091		(134		)	355,977
Corporate bonds	7,032		177		—			7,209
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	491,101		10,501		(162		)	501,440
Other securities	1,200		—		—			1,200
	$	1,083,252	$	21,789	$	(521	)	$	1,104,520
December 31, 2018
U.S. treasuries	$	30,110	$	—	$	(467	)	$	29,643
Government agency securities	152,969		80		(2,819		)	150,230
Obligations of state and municipal subdivisions	187,366		727		(3,086		)	185,007
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	326,168		128		(5,826		)	320,470
	$	696,613	$	935	$	(12,198	)	$	685,350

Securities with a carrying amount of approximately $207,999 and $219,927 at June 30, 2019 and December 31, 2018, 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 six months ended June 30, 2019 and 2018 were as follows:



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Proceeds from sale	$	4,196	$	12,672	$	189,704	$	27,473
Gross gains	$	20	$	88	$	293	$	103
Gross losses	$	—	$	98	$	28	$	337

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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 June 30, 2019, 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.



	June 30, 2019
	Securities Available for Sale
	Amortized Cost		Fair Value
Due in one year or less	$	51,225	$	51,178
Due from one year to five years	195,941		198,126
Due from five to ten years	187,726		191,861
Thereafter	157,259		161,915
	592,151		603,080
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	491,101		501,440
	$	1,083,252	$	1,104,520

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 June 30, 2019 and December 31, 2018, 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
June 30, 2019
U.S. treasuries	—	$	—	$	—		3	$	10,114	$	(35	)	$	10,114	$	(35	)
Government agency securities	2	12,307		(12		)	21	52,414		(178		)	64,721		(190		)
Obligations of state and municipal subdivisions	2	836		(1		)	22	16,639		(133		)	17,475		(134		)
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	3	4,084		(9		)	17	35,488		(153		)	39,572		(162		)
	7	$	17,227	$	(22	)	63	$	114,655	$	(499	)	$	131,882	$	(521	)
December 31, 2018
U.S. treasuries	1	$	9,749	$	(6	)	5	$	19,894	$	(461	)	$	29,643	$	(467	)
Government agency securities	4	6,068		(32		)	43	126,745		(2,787		)	132,813		(2,819		)
Obligations of state and municipal subdivisions	88	32,493		(326		)	218	105,817		(2,760		)	138,310		(3,086		)
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	56	112,114		(1,031		)	101	186,713		(4,795		)	298,827		(5,826		)
	149	$	160,424	$	(1,395	)	367	$	439,169	$	(10,803	)	$	599,593	$	(12,198	)

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.

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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 June 30, 2019 and December 31, 2018, consisted of the following:



	June 30,			December 31,
	2019			2018
Commercial	$	2,220,172		$	1,361,104
Real estate:
Commercial	5,831,466			4,141,356
Commercial construction, land and land development	1,164,789			905,421
Residential	1,466,978			1,049,521
Single-family interim construction	379,422			331,748
Agricultural	107,685			66,638
Consumer	66,432			31,759
Other	589			253
	11,237,533			7,887,800
Deferred loan fees	(2,581		)	(3,303		)
Allowance for loan losses	(51,075		)	(44,802		)
	$	11,183,877		$	7,839,695

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. Additionally, our commercial loan portfolio 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 June 30, 2019 and December 31, 2018, there were approximately $174,399 and $135,034 of energy related loans outstanding, respectively. The Company has a mortgage warehouse purchase program, which provides a mortgage warehouse lending vehicle to third party 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 commercial loans since the loans are secured by notes receivable, not real estate. As of June 30, 2019 and December 31, 2018, mortgage warehouse purchase loans outstanding totaled $453,492 and $170,290, respectively.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

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. At June 30, 2019, the portfolio consisted of approximately 30% of owner occupied property.

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 and the State of Colorado, specifically along the Front Range area. As of June 30, 2019, loans in the Colorado region represented about 29% of the total portfolio. A large percentage of the Company’s portfolio consists of commercial and residential real estate loans. As of June 30, 2019 and December 31, 2018, 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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

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 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 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 $3,825 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, continued to expand at a moderate pace during the second quarter of 2019. The Texas economy, which is the second largest in the nation, and the Colorado economy are above the U.S. economy in job creation and employment growth. Overall, the forecast is positive with continued moderate growth in the manufacturing and service sectors. The Texas and Colorado economies are expected to continue to grow in 2019 at a slower pace with a weakened outlook due to uncertainties about tariffs and trade relations, a tight labor market making it difficult to find workers and the fading impact of the 2018 federal tax cuts. The risk of loss associated with all segments of the portfolio could increase due to these factors.

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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 six months ended June 30, 2019 and 2018:



	Commercial			Commercial Real Estate, Construction, Land and Land Development			Residential Real Estate			Single-Family Interim Construction			Agricultural			Consumer			Other			Unallocated			Total
Three months ended June 30, 2019
Balance at beginning of period	$	12,295		$	28,708		$	3,494		$	1,461		$	284		$	167		$	28		$	68		$	46,505
Provision for loan losses	3,443			957			202			50			59			79			89			(140		)	4,739
Charge-offs	(69		)	(3		)	—			—			—			(12		)	(138		)	—			(222		)
Recoveries	8			—			—			—			—			18			27			—			53
Balance at end of period	$	15,677		$	29,662		$	3,696		$	1,511		$	343		$	252		$	6		$	(72	)	$	51,075

Six months ended June 30, 2019
Balance at beginning of period	$	11,793		$	27,795		$	3,320		$	1,402		$	241		$	186		$	3		$	62		$	44,802
Provision for loan losses	5,356			1,867			469			112			102			53			138			(134		)	7,963
Charge-offs	(1,523		)	(3		)	(93		)	(3		)	—			(20		)	(179		)	—			(1,821		)
Recoveries	51			3			—			—			—			33			44			—			131
Balance at end of period	$	15,677		$	29,662		$	3,696		$	1,511		$	343		$	252		$	6		$	(72	)	$	51,075

Three months ended June 30, 2018
Balance at beginning of period	$	12,261		$	24,219		$	3,589		$	1,636		$	248		$	180		$	4		$	(177	)	$	41,960
Provision for loan losses	556			2,310			(268		)	7			(24		)	8			29			112			2,730
Charge-offs	(1,013		)	(342		)	(2		)	—			—			(3		)	(47		)	—			(1,407		)
Recoveries	1			5			—			—			—			2			17			—			25
Balance at end of period	$	11,805		$	26,192		$	3,319		$	1,643		$	224		$	187		$	3		$	(65	)	$	43,308

Six months ended June 30, 2018
Balance at beginning of period	$	10,599		$	23,301		$	3,447		$	1,583		$	250		$	205		$	(32	)	$	49		$	39,402
Provision for loan losses	2,296			3,236			(125		)	60			(26		)	(2		)	100			(114		)	5,425
Charge-offs	(1,095		)	(353		)	(5		)	—			—			(19		)	(95		)	—			(1,567		)
Recoveries	5			8			2			—			—			3			30			—			48
Balance at end of period	$	11,805		$	26,192		$	3,319		$	1,643		$	224		$	187		$	3		$	(65	)	$	43,308

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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 June 30, 2019 and December 31, 2018:



	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Unallocated			Total
June 30, 2019
Allowance for losses:
Individually evaluated for impairment	$	3,899	$	—	$	47	$	—	$	—	$	2	$	—	$	—		$	3,948
Collectively evaluated for impairment	11,736		29,662		3,649		1,511		343		250		6		(72		)	47,085
Loans acquired with deteriorated credit quality	42		—		—		—		—		—		—		—			42
Ending balance	$	15,677	$	29,662	$	3,696	$	1,511	$	343	$	252	$	6	$	(72	)	$	51,075

Loans:
Individually evaluated for impairment	$	9,510	$	5,063	$	1,448	$	—	$	—	$	38	$	—	$	—		$	16,059
Collectively evaluated for impairment	2,118,323		6,745,107		1,457,436		379,422		103,076		66,367		589		—			10,870,320
Acquired with deteriorated credit quality	92,339		246,085		8,094		—		4,609		27		—		—			351,154
Ending balance	$	2,220,172	$	6,996,255	$	1,466,978	$	379,422	$	107,685	$	66,432	$	589	$	—		$	11,237,533

December 31, 2018
Allowance for losses:
Individually evaluated for impairment	$	2,633	$	—	$	92	$	—	$	—	$	2	$	—	$	—		$	2,727
Collectively evaluated for impairment	9,115		27,795		3,228		1,402		241		184		3		62			42,030
Loans acquired with deteriorated credit quality	45		—		—		—		—		—		—		—			45
Ending balance	$	11,793	$	27,795	$	3,320	$	1,402	$	241	$	186	$	3	$	62		$	44,802

Loans:
Individually evaluated for impairment	$	7,288	$	1,734	$	1,943	$	3,578	$	—	$	32	$	—	$	—		$	14,575
Collectively evaluated for impairment	1,335,194		4,955,178		1,044,265		328,170		66,032		31,699		253		—			7,760,791
Acquired with deteriorated credit quality	18,622		89,865		3,313		—		606		28		—		—			112,434
Ending balance	$	1,361,104	$	5,046,777	$	1,049,521	$	331,748	$	66,638	$	31,759	$	253	$	—		$	7,887,800

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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 June 30, 2019 and December 31, 2018, are summarized as follows:



	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Total
June 30, 2019
Nonaccrual loans	$	9,510	$	4,685	$	1,284	$	—	$	—	$	38	$	—	$	15,517
Loans past due 90 days and still accruing	845		—		—		—		—		—		—		845
Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)	—		378		164		—		—		—		—		542
	$	10,355	$	5,063	$	1,448	$	—	$	—	$	38	$	—	$	16,904
December 31, 2018
Nonaccrual loans	$	5,224	$	1,329	$	1,775	$	3,578	$	—	$	32	$	—	$	11,938
Loans past due 90 days and still accruing	—		—		—		—		—		5		—		5
Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)	114		405		168		—		—		—		—		687
	$	5,338	$	1,734	$	1,943	$	3,578	$	—	$	37	$	—	$	12,630

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 according to contractual terms of the loan agreement will not be collected. 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.

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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 June 30, 2019 and December 31, 2018, are summarized as follows:



	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Total
June 30, 2019
Recorded investment in impaired loans:
Impaired loans with an allowance for loan losses	$	8,459	$	—	$	47	$	—	$	—	$	1	$	—	$	8,507
Impaired loans with no allowance for loan losses	1,051		5,063		1,401		—		—		37		—		7,552
Total	$	9,510	$	5,063	$	1,448	$	—	$	—	$	38	$	—	$	16,059
Unpaid principal balance of impaired loans	$	9,558	$	5,187	$	1,586	$	—	$	—	$	39	$	—	$	16,370
Allowance for loan losses on impaired loans	$	3,899	$	—	$	47	$	—	$	—	$	2	$	—	$	3,948
December 31, 2018
Recorded investment in impaired loans:
Impaired loans with an allowance for loan losses	$	6,416	$	—	$	134	$	—	$	—	$	1	$	—	$	6,551
Impaired loans with no allowance for loan losses	872		1,734		1,809		3,578		—		31		—		8,024
Total	$	7,288	$	1,734	$	1,943	$	3,578	$	—	$	32	$	—	$	14,575
Unpaid principal balance of impaired loans	$	9,822	$	1,860	$	2,056	$	3,579	$	—	$	38	$	—	$	17,355
Allowance for loan losses on impaired loans	$	2,633	$	—	$	92	$	—	$	—	$	2	$	—	$	2,727
For the three months ended June 30, 2019
Average recorded investment in impaired loans	$	8,730	$	3,197	$	1,397	$	—	$	—	$	31	$	—	$	13,355
Interest income recognized on impaired loans	$	3	$	6	$	28	$	5	$	—	$	—	$	—	$	42
For the six months ended June 30, 2019
Average recorded investment in impaired loans	$	8,249	$	2,709	$	1,579	$	1,193	$	—	$	31	$	—	$	13,761
Interest income recognized on impaired loans	$	21	$	28	$	32	$	114	$	—	$	5	$	—	$	200
For the three months ended June 30, 2018
Average recorded investment in impaired loans	$	9,517	$	3,015	$	2,205	$	—	$	—	$	46	$	—	$	14,783
Interest income recognized on impaired loans	$	17	$	8	$	37	$	—	$	—	$	—	$	—	$	62
For the six months ended June 30, 2018
Average recorded investment in impaired loans	$	9,777	$	3,028	$	2,045	$	—	$	—	$	55	$	—	$	14,905
Interest income recognized on impaired loans	$	20	$	14	$	43	$	—	$	—	$	1	$	—	$	78

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

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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 $1,986 and $1,925 as of June 30, 2019 and December 31, 2018, respectively.

Following is a summary of loans modified under troubled debt restructurings during the three and six months ended June 30, 2019:




	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Total
Troubled debt restructurings during the three months ended June 30, 2019
Number of contracts	—		—		1		—		—		—		—		1
Pre-restructuring outstanding recorded investment	$	—	$	—	$	239	$	—	$	—	$	—	$	—	$	239
Post-restructuring outstanding recorded investment	$	—	$	—	$	239	$	—	$	—	$	—	$	—	$	239

Troubled debt restructurings during the six months ended June 30, 2019
Number of contracts	—		—		1		—		—		—		—		1
Pre-restructuring outstanding recorded investment	$	—	$	—	$	239	$	—	$	—	$	—	$	—	$	239
Post-restructuring outstanding recorded investment	$	—	$	—	$	239	$	—	$	—	$	—	$	—	$	239

There were no loans modified under troubled debt restructurings during the three and six months ended June 30, 2018.

At June 30, 2019 and 2018, there were no loans modified under troubled debt restructurings during the previous twelve month period that subsequently defaulted during the three and six months ended June 30, 2019 and 2018, respectively. At June 30, 2019 and 2018, the Company had no commitments to lend additional funds to any borrowers with loans whose terms have been modified under troubled debt restructurings.

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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 June 30, 2019 and December 31, 2018:



	Loans 30-89 Days Past Due		Loans 90 Days or More Past Due		Total Past Due Loans		Current Loans		Total Loans
June 30, 2019
Commercial	$	20,910	$	9,959	$	30,869	$	2,096,964	$	2,127,833
Commercial real estate, construction, land and land development	3,689		3,283		6,972		6,743,198		6,750,170
Residential real estate	2,193		559		2,752		1,456,132		1,458,884
Single-family interim construction	82		—		82		379,340		379,422
Agricultural	190		—		190		102,886		103,076
Consumer	257		32		289		66,116		66,405
Other	—		—		—		589		589
	27,321		13,833		41,154		10,845,225		10,886,379
Acquired with deteriorated credit quality	3,769		6,012		9,781		341,373		351,154
	$	31,090	$	19,845	$	50,935	$	11,186,598	$	11,237,533
December 31, 2018
Commercial	$	15,426	$	4,366	$	19,792	$	1,322,690	$	1,342,482
Commercial real estate, construction, land and land development	3,435		—		3,435		4,953,477		4,956,912
Residential real estate	4,199		1,035		5,234		1,040,974		1,046,208
Single-family interim construction	774		3,578		4,352		327,396		331,748
Agricultural	—		—		—		66,032		66,032
Consumer	135		35		170		31,561		31,731
Other	—		—		—		253		253
	23,969		9,014		32,983		7,742,383		7,775,366
Acquired with deteriorated credit quality	2,939		957		3,896		108,538		112,434
	$	26,908	$	9,971	$	36,879	$	7,850,921	$	7,887,800

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 a 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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

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 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 June 30, 2019 and December 31, 2018, is as follows:



	Pass		Pass/ Watch		Special Mention		Substandard		Doubtful		Total
June 30, 2019
Commercial	$	2,077,515	$	39,641	$	66,745	$	36,271	$	—	$	2,220,172
Commercial real estate, construction, land and land development	6,772,100		140,645		51,793		31,717		—		6,996,255
Residential real estate	1,454,242		3,872		309		8,555		—		1,466,978
Single-family interim construction	378,868		—		554		—		—		379,422
Agricultural	98,034		3,152		4,219		2,280		—		107,685
Consumer	66,231		49		—		152		—		66,432
Other	589		—		—		—		—		589
	$	10,847,579	$	187,359	$	123,620	$	78,975	$	—	$	11,237,533
December 31, 2018
Commercial	$	1,279,024	$	18,378	$	30,783	$	32,919	$	—	$	1,361,104
Commercial real estate, construction, land and land development	4,895,217		81,693		40,601		29,266		—		5,046,777
Residential real estate	1,038,283		3,617		707		6,914		—		1,049,521
Single-family interim construction	327,939		—		231		3,578		—		331,748
Agricultural	61,055		2,918		2,093		572		—		66,638
Consumer	31,559		67		—		133		—		31,759
Other	253		—		—		—		—		253
	$	7,633,330	$	106,673	$	74,415	$	73,382	$	—	$	7,887,800

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 June 30, 2019 and December 31, 2018:



	Pass		Pass/ Watch		Special Mention		Substandard		Doubtful		Total
June 30, 2019	$	271,951	$	40,923	$	9,804	$	28,476	$	—	$	351,154
December 31, 2018	40,940		32,427		14,817		24,250		—		112,434

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 June 30, 2019 and December 31, 2018, nonaccrual PCI loans were $12,496 and $6,996, respectively.

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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 by acquired bank as of the acquisition date for the acquisitions occurring in 2019 and 2018:



	Acquisition Date
	January 1, 2019			June 1, 2018
	Guaranty Bancorp			Integrity Bancshares, Inc.
Outstanding balance	$	341,645		$	57,317
Nonaccretable difference	(16,622		)	(9,969		)
Accretable yield	(13,299		)	(128		)
Carrying amount	$	311,724		$	47,220

The carrying amount of all acquired PCI loans included in the consolidated balance sheet and the related outstanding balance at June 30, 2019 and December 31, 2018 were as follows:



	June 30, 2019		December 31, 2018
Outstanding balance	$	390,437	$	129,333
Carrying amount	351,154		112,434

There was an allocation of $42 and $45 established in the allowance for loan losses relating to PCI loans at June 30, 2019 and December 31, 2018, respectively.

The changes in accretable yield during the six months ended June 30, 2019 and 2018 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 Six Months Ended June 30,
	2019			2018
Balance at January 1,	$	1,436		$	1,546
Additions	13,299			—
Accretion	(2,799		)	(1,121		)
Transfers from nonaccretable	—			1,286
Balance at June 30,	$	11,936		$	1,711

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

Note 5. Other Borrowings and Junior Subordinated Debentures

Other borrowings totaled $212,534 and $137,316 at June 30, 2019 and December 31, 2018, respectively. Junior subordinated debentures totaled $53,725 and $27,852 at June 30, 2019 and December 31, 2018, respectively.

In connection with the Guaranty acquisition on January 1, 2019, as further discussed in Note 13, Business Combinations, the Company assumed $40,000 in aggregate principal of 5.75% fixed and floating rate subordinated notes due July 20, 2026 and trust preferred securities totaling $25,774 issued under two wholly-owned statutory business trusts, Guaranty Capital Trust III and Cenbank Statutory Trust III.

As of June 30, 2019, the Company had $35,000 of borrowings against its revolving line of credit with an unrelated commercial bank. There were no borrowings against the line as of December 31, 2018.

Note 6. Leases

On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842). Under this guidance, lessor accounting is largely unchanged. This ASU became effective for annual and interim periods for the Company on January 1, 2019. The Company adopted the standard by applying the alternative transition method whereby comparative periods were not restated, and an immaterial cumulative effect adjustment to the opening balance of retained earnings was recognized as of January 1, 2019. The Company also elected the ASU’s package of three practical expedients, which allowed the Company to forego a reassessment of (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases and (iii) the initial direct costs for any existing leases. The Company also elected not to apply the recognition requirements of the ASU to any short-term leases (as defined by related accounting guidance) and will account for lease and non-lease components separately because such amounts are readily determinable under most lease contracts and because this election results in a lower impact on the Company's balance sheet.

The Company’s primary leasing activities relate to certain real estate leases entered into in support of the Company’s branch operations and back office operations. The Company leases 22 of its 95 branches. The Company’s branch locations operated under lease agreements have all been designated as operating leases. In addition, the Company leases certain equipment under operating leases. The Company does not have leases designated as finance leases.

The Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities in the consolidated balance sheets. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU asset also includes any lease pre-payments made and excludes lease incentives. The Company's lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company has lease agreements with lease and non-lease components, which the Company has elected to account for separately as the non-lease component amounts are readily determinable under most leases.

As of June 30, 2019 the Company’s lease ROU assets and related lease liabilities were $36,037 and $31,893, respectively, and have remaining terms ranging from 1 to 32 years, including extension options that the Company is reasonably certain will be exercised.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

The table below summarizes net lease cost:



	Three Months Ended June 30,			Six Months Ended June 30,
	2019			2019
Operating lease cost	$	1,891		$	3,783
Variable lease cost	508			1,002
Sublease income	(57		)	(114		)
Net lease cost	$	2,342		$	4,671

The table below summarizes other information related to operating leases:



	Six Months Ended June 30,
	2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	3,452
ROU assets obtained in exchange for lease liabilities	39,739
Weighted average remaining lease term - operating leases, in years	7.73
Weighted average discount rate - operating leases	3.38		%

The following table outlines lease payment obligations as outlined in the Company’s lease agreements for each of the next five years and thereafter in addition to a reconcilement to the Company’s current lease liability as of June 30, 2019.



2019	$	7,163
2020	5,830
2021	5,227
2022	4,631
2023	3,585
Thereafter	9,761
Total lease payments	36,197
Less imputed interest	(4,304		)
	$	31,893

As of June 30, 2019, the Company had not entered into any material leases that have not yet commenced.

Note 7. 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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

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 June 30, 2019 and December 31, 2018, the approximate amounts of these financial instruments were as follows:



	June 30,		December 31,
	2019		2018
Commitments to extend credit	$	2,415,721	$	1,761,724
Standby letters of credit	24,393		14,997
	$	2,440,114	$	1,776,721

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 June 30, 2019 and December 31, 2018, 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. 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 its acquisition of BOH Holdings, Inc. and its subsidiary, Bank of Houston (BOH). The plaintiffs in the case are alleging that Independent Bank aided and abetted or participated in a fraudulent scheme. Independent Bank is pursuing insurance coverage for these claims, including reimbursement for defense costs. The Company believes the claims made in this lawsuit are without merit and is vigorously defending the lawsuit. The Company is unable to predict when the matter will be resolved, the ultimate outcome or potential costs or damages to be incurred. Please see Part II, Item 1. for more details on this lawsuit.

Note 8. Income Taxes

Income tax expense for the three and six months ended June 30, 2019 and 2018 was as follows:



	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Income tax expense for the period	$	13,389		$	7,519		$	24,515		$	14,324
Effective tax rate	21.2		%	20.2		%	22.0		%	19.6		%

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

The effective tax rates for 2019 and 2018 differ from the statutory federal tax rate of 21% largely due to tax exempt interest income earned on certain investment securities and loans, the nontaxable earnings on bank owned life insurance, excess tax expense and benefits on restricted stock vestings, nondeductible compensation, acquisition related expenses, and state income tax.

Note 9. 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.

The Company elected the fair value option for certain residential mortgage loans held for sale originated after July 1, 2018 in accordance with Accounting Standard Codification (ASC) 825, Financial Instruments. This election allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under ASC 815, Derivatives and Hedging. The Company has not elected the fair value option for other residential mortgage loans held for sale primarily because they are not economically hedged using derivative instruments. See below and Note 10, Derivative Financial Instruments, for additional information.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

Assets and Liabilities Measured on a Recurring Basis

The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of June 30, 2019 and December 31, 2018 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)
June 30, 2019
Assets:
Investment securities available for sale:
U.S. treasuries	$	50,833	$	—	$	50,833	$	—
Government agency securities	187,861		—		187,861		—
Obligations of state and municipal subdivisions	355,977		—		355,977		—
Corporate bonds	7,209		—		7,209		—
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	501,440		—		501,440		—
Other securities	1,200		—		1,200		—
Total investment securities available for sale	$	1,104,520	$	—	$	1,104,520	$	—

Loans held for sale, fair value option elected ⁽¹⁾	$	17,988	$	—	$	17,988	$	—
Derivative financial instruments:
Interest rate lock commitments	1,378		—		1,378		—
Loan customer counterparty	5,022		—		5,022		—
Financial institution counterparty	17		—		17		—
Liabilities:
Derivative financial instruments:
Forward mortgage-backed securities trades	131		—		131		—
Loan customer counterparty	18		—		18		—
Financial institution counterparty	5,408		—		5,408		—
December 31, 2018
Assets:
Investment securities available for sale:
U.S. treasuries	$	29,643	$	—	$	29,643	$	—
Government agency securities	150,230		—		150,230		—
Obligations of state and municipal subdivisions	185,007		—		185,007		—
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	320,470		—		320,470		—
Total investment securities available for sale	$	685,350	$	—	$	685,350	$	—

Loans held for sale, fair value option elected ⁽¹⁾	$	27,871	$	—	$	27,871	$	—
Derivative financial instruments:
Interest rate lock commitments	822		—		822		—
Loan customer counterparty	360		—		360		—
Financial institution counterparty	109		—		109		—
Liabilities:
Derivative financial instruments:
Forward mortgage-backed securities trades	226		—		226		—
Loan customer counterparty	108		—		108		—
Financial institution counterparty	406		—		406		—

⁽¹⁾ At June 30, 2019 and December 31, 2018, loans held for sale for which the fair value option was elected had an aggregate outstanding principal balance of $17,292 and $26,594. There were no mortgage loans held for sale under the fair value option that were 90 days or greater past due or on nonaccrual at June 30, 2019.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

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.

Certain mortgage loans held for sale are measured at fair value on a recurring basis due to the Company's election to adopt fair value accounting treatment for those loans originated after July 1, 2018 for which the Company has entered into certain derivative financial instruments as part of its mortgage banking and related risk management activities. These instruments include interest rate lock commitments and mandatory forward commitments to sell these loans to investors known as forward mortgage-backed securities trades. This election allows for a more effective offset of the changes in fair values of the assets and the mortgage related derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under ASC 815, Derivatives and Hedging. Mortgage loans held for sale, for which the fair value option was elected, which are sold on a servicing released basis, are valued using a market approach by utilizing either: (i) the fair value of securities backed by similar mortgage loans, adjusted for certain factors to approximate the fair value of a whole mortgage loan, including the value attributable to mortgage servicing and credit risk, (ii) current commitments to purchase loans or (iii) recent observable market trades for similar loans, adjusted to credit risk and other individual loan characteristics. As these prices are derived from market observable inputs, the Company classifies these valuations as Level 2 in the fair value disclosures. For mortgage loans held for sale for which the fair value option was elected, the earned current contractual interest payment is recognized in interest income, loan origination costs and fees on fair value option loans are recognized in earnings as incurred and not deferred. The Company has no continuing involvement in any residential mortgage loans sold.

The estimated fair values of interest rate lock commitments utilize current secondary market prices for underlying loans and estimated servicing value with similar coupons, maturity and credit quality, subject to the anticipated loan funding probability (pull-through rate). The fair value of interest rate lock commitments is subject to change primarily due to changes in interest rates and the estimated pull-through rate. These commitments are classified as Level 2 in the fair value disclosures, as the valuations are based on observable market inputs.

Forward mortgage-backed securities trades are exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilized the exchange price or dealer market price for the particular derivative contract; therefore these contracts are classified as Level 2. The estimated fair values are subject to change primarily due to changes in interest rates.

The Company also enters into certain interest rate derivative positions that are not designated as hedging instruments. The estimated fair value of these commercial loan interest rate swaps are obtained from a pricing service that provides the swaps' unwind value (Level 2 inputs). See Note 10, Derivative Financial Instruments, for more information.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

Assets and Liabilities Measured on a Nonrecurring Basis

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 June 30, 2019 and December 31, 2018, 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
June 30, 2019
Assets:
Impaired loans	$	2,047	$	—	$	—	$	2,047	$	2,368
Other real estate	9,182		—		—		9,182		1,424

December 31, 2018
Assets:
Impaired loans	$	3,824	$	—	$	—	$	3,824	$	2,227

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. Therefore, the Company has categorized its other real estate as Level 3.

In addition, mortgage loans held for sale not recorded under the fair value option are required to be measured at the lower of cost or fair value. The fair value of these loans is based upon binding quotes or bids from third party investors. As of June 30, 2019 and December 31, 2018, all mortgage loans held for sale not recorded under the fair value option were recorded at cost.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

Fair Value of Financial Instruments not Recorded at Fair Value

The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial instruments that are reported at amortized cost on the Company's consolidated balance sheets were as follows at June 30, 2019 and December 31, 2018:



					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)
June 30, 2019
Financial assets:
Cash and cash equivalents	$	579,447	$	579,447	$	579,447	$	—	$	—
Certificates of deposit held in other banks	5,216		5,470		—		5,470		—
Loans held for sale, at cost	88,501		95,934		—		95,934		—
Loans, net	11,183,877		11,345,141		—		11,340,582		4,559
FHLB of Dallas stock and other restricted stock	33,346		33,346		—		33,346		—
Accrued interest receivable	40,023		40,023		—		40,023		—
Financial liabilities:
Deposits	11,530,587		11,552,436		—		11,552,436		—
Accrued interest payable	11,108		11,108		—		11,108		—
FHLB advances	580,000		579,725		—		579,725		—
Other borrowings	212,534		221,225		—		221,225		—
Junior subordinated debentures	53,725		50,720		—		50,720		—
Off-balance sheet assets (liabilities):
Commitments to extend credit	—		—		—		—		—
Standby letters of credit	—		—		—		—		—
December 31, 2018
Financial assets:
Cash and cash equivalents	$	130,779	$	130,779	$	130,779	$	—	$	—
Certificates of deposit held in other banks	1,225		1,224		—		1,224		—
Loans held for sale, at cost	4,856		4,974		—		4,974		—
Loans, net	7,839,695		7,807,823		—		7,803,999		3,824
FHLB of Dallas stock and other restricted stock	26,870		26,870		—		26,870		—
Accrued interest receivable	24,253		24,253		—		24,253		—
Financial liabilities:
Deposits	7,737,794		7,750,059		—		7,750,059		—
Accrued interest payable	6,183		6,183		—		6,183		—
FHLB advances	290,000		287,450		—		287,450		—
Other borrowings	137,316		138,450		—		138,450		—
Junior subordinated debentures	27,852		31,370		—		31,370		—
Off-balance sheet assets (liabilities):
Commitments to extend credit	—		—		—		—		—
Standby letters of credit	—		—		—		—		—

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

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, as amended by ASU 2016-01 requiring public entities to use the exit price notion effective January 1, 2018, 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 market rates.

Loans held for sale, at cost: The fair value of loans held for sale is determined based upon commitments on hand from investors.

Loans: A discounted cash flow model is used to estimate the fair value of the loans. The discounted cash flow approach models the credit losses directly in the projected cash flows, applying various assumptions regarding credit, interest and prepayment risks for the loans based on loan types, payment types and fixed or variable classifications.

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.

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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

Note 10. Derivative Financial Instruments

The Company enters into certain derivative financial instruments as part of its hedging strategy. These financial instruments are not designated as hedging instruments and are used for asset and liability management related to the Company's mortgage banking activities and commercial customers' financing needs. All derivatives are carried at fair value in either other assets or other liabilities.

Through the normal course of business, the Company enters into interest rate lock commitments with consumers to originate mortgage loans at a specified interest rate. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company.

During July 2018, the Company began managing the changes in fair value associated with changes in interest rates related to interest rate lock commitments by using forward sold commitments known as forward mortgage-backed securities trades. These instruments are typically entered into at the time the interest rate lock commitment is made.

The Company also offers certain derivatives products, primarily interest rate swaps, directly to qualified commercial banking customers to facilitate their risk management strategies. The interest rate swap derivative positions relate to transactions in which the Company enters into an interest rate swap with a customer, while at the same time entering into an offsetting interest rate swap with another financial institution. An interest rate swap transaction allows customers to effectively convert a variable rate loan to a fixed rate. In connection with each swap, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. These products were not significant for disclosure in prior periods.

The following table provides the outstanding notional balances and fair values of outstanding derivative positions at June 30, 2019 and December 31, 2018:



	Outstanding Notional Balance		Asset Derivative Fair Value		Liability Derivative Fair Value
June 30, 2019
Interest rate lock commitments	$	48,020	$	1,378	$	—
Forward mortgage-backed securities trades	40,500		—		131
Commercial loan interest rate swaps:
Loan customer counterparty	142,247		5,022		18
Financial institution counterparty	142,247		17		5,408

December 31, 2018
Interest rate lock commitments	$	20,306	$	822	$	—
Forward mortgage-backed securities trades	27,500		—		226
Commercial loan interest rate swaps:
Loan customer counterparty	25,055		360		108
Financial institution counterparty	25,055		109		406

The credit exposure related to interest rate swaps is limited to the net favorable value of all swaps by each counterparty, which was approximately $5,022 at June 30, 2019.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

The initial and subsequent changes in the fair value of interest rate lock commitments and the forward sales of mortgage-back securities are recorded in mortgage banking revenue. These gains and losses were not attributable to instrument-specific credit risk. For interest rate swaps, because the Company acts as an intermediary for our customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on the results of operations.

Income for the three and six months ended June 30, 2019 was as follows:



	Three Months Ended June 30,		Six Months Ended June 30,
	2019		2019
Derivatives not designated as hedging instruments
Interest rate lock commitments	$	126	$	556
Forward mortgage-backed securities trades	86		95

Note 11. Stock Awards and Stock Warrants

The Company grants common stock awards to certain employees of the Company. In connection with the Company's initial public offering in April 2013, the Board of Directors adopted the 2013 Equity Incentive Plan. Under this plan, the Compensation Committee may grant awards to certain employees of the Company 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. All stock awards issued under expired plans prior to 2013 are fully vested. In May 2018, the shareholders of the Company voted to amend the plan to increase the reserved shares of common stock to be awarded by the Company’s compensation committee by 1,500,000 for a total of 2,300,000 reserved shares. As of June 30, 2019, there were 1,442,219 shares remaining available for grant for future awards. The shares currently issued under the 2013 Plan are restricted stock awards and will vest evenly over the required employment period, generally ranging from three to five years. Shares granted under the 2013 Equity Incentive Plan were issued at the date of grant and receive dividends.

In connection with the acquisition of Guaranty, as further described in Note 13, Business Combinations, unvested awards of restricted Guaranty common stock granted under Guaranty’s 2015 Long-Term Incentive Plan (Guaranty 2015 RSA), as amended, that were outstanding as of January 1, 2019, the acquisition date, were converted into awards of restricted shares of Independent common stock (Replacement RSA) with the same terms and conditions as were applicable under such Guaranty 2015 RSA, except with respect to any performance-vesting Guaranty 2015 RSA, which became a service-vesting RSA only. The Replacement RSA will vest over the remaining service period, generally in two years, and do not receive dividends.

The following table summarizes the activity in nonvested shares for the six months ended June 30, 2019 and 2018:



	Number of Shares		Weighted Average Grant Date Fair Value
Nonvested shares, December 31, 2018	252,903		$	62.81
Acquired awards replaced during the period	70,248		45.77
Granted during the period	133,611		51.20
Vested during the period	(130,644	)	54.60
Forfeited during the period	(8,218	)	34.94
Nonvested shares, June 30, 2019	317,900		$	47.56

Nonvested shares, December 31, 2017	242,056		$	49.17
Granted during the period	118,912		72.36
Vested during the period	(105,385	)	43.78
Forfeited during the period	(3,845	)	64.47
Nonvested shares, June 30, 2018	251,738		$	62.15

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

Compensation expense related to these awards is recorded based on the fair value of the award at the date of grant and totaled $1,752 and $3,924 for the three and six months ended June 30, 2019, respectively, and $1,543 and $2,955 for the three and six months ended June 30, 2018, respectively. Compensation expense is recorded in salaries and employee benefits in the accompanying consolidated statements of income. At June 30, 2019, future compensation expense is estimated to be $15,120 and will be recognized over a remaining weighted average period of 2.72 years.

The fair value of common stock awards that vested during the six months ended June 30, 2019 and 2018 was $7,088 and $7,539, respectively. The Company recorded $30 and $10 in excess tax expense (benefits) on vested restricted stock to income tax expense for the three and six months ended June 30, 2019, respectively, and ($264) and ($613) for the three and six months ended June 30, 2018, respectively.

There were no modifications of stock agreements during the six months ended June 30, 2019 and 2018 that resulted in significant additional incremental compensation costs.

At June 30, 2019, the future vesting schedule of the nonvested shares is as follows:



First year		123,083
Second year		103,407
Third year		66,010
Fourth year		21,840
Fifth year		3,560
Total nonvested shares		317,900

Note 12. 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. Tier 2 capital for the Company includes permissible portions of the Company's subordinated notes. The permissible portion of qualified subordinated notes decreases 20% per year during the final five years of the term of the notes.

The Company is subject to the Basel III regulatory capital framework (the "Basel III Capital Rules"). The implementation of the capital conservation buffer was effective for the Company on January 1, 2016 at the 0.625% level and was phased in over a four-year period increasing by 0.625% each year, until it reached 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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

Fully phased in on January 1, 2019, the Basel III Capital Rules require the Company and Bank to maintain (i) a minimum ratio of Common Equity Tier 1 ("CET1") capital to risk-weighted assets of at least 4.5%, plus the 2.5% capital conservation buffer (7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (8.5%), (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (10.5%) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average quarterly assets.

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 June 30, 2019 and December 31, 2018, the Company and the Bank meet all capital adequacy requirements to which they are subject, including the capital buffer requirement.

As of June 30, 2019 and December 31, 2018, 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 that management believes have changed the Bank’s category.

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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 the actual capital amounts and required ratios of the Company and Bank as of June 30, 2019 and December 31, 2018. The minimum required capital amounts presented as of June 30, 2019 include the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules have been fully phased-in.



	Actual				Minimum Capital Required				Required to be Considered Well Capitalized
	Amount		Ratio		Amount		Ratio		Amount		Ratio
June 30, 2019
Total capital to risk weighted assets:
Consolidated	$	1,436,886	11.54	%	$	1,307,076	10.50	%	N/A		N/A
Bank	1,455,137		11.66		1,309,937		10.50		$	1,247,559	10.00	%
Tier 1 capital to risk weighted assets:
Consolidated	1,205,811		9.69		1,058,109		8.50		N/A		N/A
Bank	1,404,062		11.25		1,060,425		8.50		998,047		8.00
Common equity tier 1 to risk weighted assets:
Consolidated	1,150,211		9.24		871,384		7.00		N/A		N/A
Bank	1,404,062		11.25		873,291		7.00		810,913		6.50
Tier 1 capital to average assets:
Consolidated	1,205,811		9.06		532,408		4.00		N/A		N/A
Bank	1,404,062		10.55		532,142		4.00		665,178		5.00

December 31, 2018
Total capital to risk weighted assets:
Consolidated	$	1,072,156	12.58	%	$	681,686	8.00	%	N/A		N/A
Bank	1,054,783		12.39		681,004		8.00		$	851,255	10.00	%
Tier 1 capital to risk weighted assets:
Consolidated	887,354		10.41		511,264		6.00		N/A		N/A
Bank	1,009,981		11.86		510,753		6.00		681,004		8.00
Common equity tier 1 to risk weighted assets:
Consolidated	856,754		10.05		383,448		4.50		N/A		N/A
Bank	1,009,981		11.86		383,065		4.50		553,316		6.50
Tier 1 capital to average assets:
Consolidated	887,354		9.57		370,727		4.00		N/A		N/A
Bank	1,009,981		10.91		370,412		4.00		463,015		5.00

Note 13. Business Combinations

Guaranty Bancorp

On January 1, 2019, the Company acquired 100% of the outstanding stock of Guaranty Bancorp (Guaranty) and its subsidiary, Guaranty Bank and Trust Company (Guaranty Bank), Denver, Colorado. As a result of the acquisition, the Company added 32 full service branch locations along the Colorado Front Range, including locations throughout the Denver metropolitan area and along I-25 to Fort Collins expanding the Company's footprint in Colorado. The Company issued 13,179,748 shares of Company stock for the outstanding shares of Guaranty common stock, including restricted stock replacement awards.

The Company has recognized total goodwill of $272,300 which is calculated as the excess of both the consideration exchanged and liabilities assumed compared to the estimated fair market value of identifiable assets acquired. The goodwill in this acquisition resulted from a combination of expected synergies and expansion into desirable Colorado markets. None of the goodwill recognized is expected to be deductible for income tax purposes.

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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 $5,430 and $23,251 for the three and six months ended June 30, 2019, respectively, which is included in salaries and benefits and acquisition expense in the consolidated statements of income. The Company incurred expense of $1,560 during the year ended December 31, 2018. In addition, for the six months ended June 30, 2019, the Company paid offering costs totaling $804 which were recorded as a reduction to stock issuance proceeds through additional paid in capital.

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:



	Initially Recorded at Acquisition Date		Measurement Period Adjustments		Adjusted Values as of June 30, 2019
Assets of acquired bank:
Cash and cash equivalents	$	39,913	$	—	$	39,913
Certificates of deposit held in other banks	262		—		262
Securities available for sale	561,052		—		561,052
Restricted stock	27,794		—		27,794
Loans	2,788,159		1,709		2,789,868
Premises and equipment	65,786		—		65,786
Other real estate owned	1,710		—		1,710
Goodwill	270,583		1,717		272,300
Other intangible assets	71,518		—		71,518
Bank owned life insurance	80,837		—		80,837
Other assets	31,517		492		32,009
Total assets acquired	$	3,939,131	$	3,918	$	3,943,049

Liabilities of acquired bank:
Deposits	$	3,108,810	$	—	$	3,108,810
Repurchase agreements	8,475		—		8,475
FHLB advances	142,653		—		142,653
Other borrowings	40,000		—		40,000
Junior subordinated debentures	25,774		—		25,774
Other liabilities	11,538		3,918		15,456
Total liabilities assumed	$	3,337,250	$	3,918	$	3,341,168
Common stock of 13,109,500 issued at $45.77 per share	$	600,022	$	—	$	600,022
Consideration attributable to 70,248 shares of restricted stock replacement awards	$	1,850	$	—	$	1,850
Cash paid	$	9	$	—	$	9

The nature of the measurement period adjustments noted in the table above was a result of information obtained subsequent to our initial reporting of provisional fair values but prior to finalizing our fair values in accordance with ASC 805, Business Combinations. Such information was determined to be a condition in existence as of acquisition date. The income effects resulting from the recorded measurement period adjustments during the period ending June 30, 2019 are immaterial for separate disclosure.

Non-credit impaired loans had a fair value of $2,478,144 at acquisition date and contractual balance of $2,573,355. As of acquisition date, the Company expects that an insignificant amount of the contractual balance of these loans will be uncollectible. The difference of $95,211 will be recognized into interest income as an adjustment to yield over the life of the loans.

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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 Guaranty acquisition was completed as of January 1, 2018. The pro-forma results combine the historical results of Guaranty into the Company's consolidated statement of income including the impact of certain purchase accounting adjustments including loan and investment discount accretion and intangible assets 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, 2018:



	Three Months Ended June 30,		Six Months Ended June 30,
	2018		2018
Interest income	$	141,511	$	272,627
Noninterest income	17,488		33,913
Total revenue	$	158,999	$	306,540
Net income	$	46,980	$	93,583
Basic earnings per share	$	1.11	$	2.24
Diluted earnings per share	$	1.11	$	2.23

Revenues and earnings of the acquired company since the acquisition date have not been disclosed as Guaranty was merged into the Company and separate financial information is not readily available.

Note 14. Subsequent Events

Declaration of Dividends

On July 24, 2019, the Company declared a quarterly cash dividend in the amount of $0.25 per share of common stock to the stockholders of record on August 5, 2019. The dividend will be paid on August 15, 2019.

Sales of Loan Pools

In July 2019, the Company completed sales of consumer and residential mortgage loan pools acquired with the Guaranty acquisition. The loan pools totaling $83,526 are reflected as held for sale as of June 30, 2019 in the accompanying consolidated balance sheet. A gain of approximately $6,835 was recognized as a result of the sales.

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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 (the “Act”) that are subject to risks and uncertainties and are made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, and other related federal securities laws. 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;


•	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;

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•	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;


•	the institution and outcome of, and costs associated with, litigation and other legal proceedings against one of more of the Company, 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, and changes in federal government policies;


•	the impact of regulatory requirements applicable to, and the supervision of, the Company resulting from the Company now being a financial institution with total assets greater than $10 billion;


•	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, including changes resulting from the implementation of the new Current Expected Credit Loss accounting standard;


•	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 the Company 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, the Company's and Independent Bank's digital information systems, the costs the Company or Independent Bank incur to provide security against such attacks and any costs and liability the Company 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 I, Item 1A. of our Annual Report on Form 10-K or our Quarterly Reports on Form 10-Q, in each case 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.

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A forward looking-statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company has chosen these assumptions or bases in good faith and believes that 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.

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, 2018.

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.

As of June 30, 2019, the Company operated 95 full service banking locations in north, central and southeast Texas regions, and along the Colorado Front Range region. During first quarter of 2019, the Company announced its intent to rebalance its retail footprint by consolidating branches in Texas and Colorado. This consolidation process resulted in the reduction of seven branches in Colorado and four branches in Texas during second quarter, with one Colorado reduction to take place during third quarter of 2019. Also in the second quarter of 2019, the Company announced its plan to sell another branch in the North Texas region, which is expected to close in third quarter 2019. As a result of the planned branch reduction, Independent Bank will have a total of 93 branches, with 61 Texas locations and 32 Colorado locations.

The Company’s headquarters are located at 7777 Henneman Way, McKinney, Texas 75070, 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, mortgage banking operations and investment advisory services. 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 (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

Acquisitions. The Company completed the acquisition of Guaranty Bancorp, a Colorado corporation and its subsidiary, Guaranty Bank and Trust Company (Guaranty), on January 1, 2019. As a result of the acquisition, the Company added 32 full service banking locations (25 after branch consolidation discussed above) along the Colorado Front Range including locations throughout the Denver metropolitan area and along I-25 to Fort Collins, expanding the Company's footprint in Colorado. This acquisition increased total assets by $3.9 billion, gross loans by $2.8 billion and deposits by $3.1 billion.

The Company completed the acquisition of Integrity Bancshares, Inc., a Texas corporation and its subsidiary, Integrity Bank, SSB, Houston, Texas (Integrity), a Texas state savings bank on June 1, 2018. The Company acquired four new locations as part of the transaction, representing an expansion in the Houston metropolitan area. This acquisition increased total assets by $851.9 million, gross loans by $651.8 million and deposits by $593.1 million.

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The comparability of the Company's results of operations for the three and six months ended June 30, 2019 and 2018 are affected by these acquisitions.

Discussion and Analysis of Results of Operations for the Three and Six Months Ended June 30, 2019 and 2018

The following discussion and analysis of our results of operations compares the operations for the three and six months ended June 30, 2019 with the three and six months ended June 30, 2018. The results of operations for the three and six months ended June 30, 2019 are not necessarily indicative of the results of operations that may be expected for all of the year ending December 31, 2019.

Results of Operations

For the three months ended June 30, 2019, net income was $49.7 million ($1.15 per common share on a diluted basis) compared with net income of $29.6 million ($1.02 per common share on a diluted basis) for the three months ended June 30, 2018. The Company posted annualized returns on average equity of 8.90% and 8.38%, returns on average assets of 1.39% and 1.30% and efficiency ratios of 51.25% and 53.64% for the three months ended June 30, 2019 and 2018, respectively. The efficiency ratio is calculated by dividing total noninterest expense (which excludes the provision for loan losses and the amortization of other intangible assets) by net interest income plus noninterest income.

For the six months ended June 30, 2019, net income was $86.9 million ($1.99 per common share on a diluted basis) compared with $58.6 million ($2.04 per common share on a diluted basis) for the six months ended June 30, 2018. The Company posted annualized returns on average common equity of 7.85% and 8.54%, returns on average assets of 1.23% and 1.33% and efficiency ratios of 55.69% and 52.99% for the six months ended June 30, 2019 and 2018, 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 $129.6 million for the three months ended June 30, 2019, an increase of $50.7 million, or 64.3%, from $78.9 million for the three months ended June 30, 2018. This increase is due primarily to a $4.7 billion increase, or 58.8%, in average interest earning assets to $12.6 billion for the three months ended June 30, 2019 compared to $8.0 billion for the three months ended June 30, 2018. The increase is primarily due to $3.4 billion in interest-earning assets acquired in the Guaranty transaction as well as $718.9 million of interest-earning assets acquired in the Integrity transaction as well as organic growth over the year. The average yield on interest earning assets increased 43 basis points from 4.89% for the three months ended June 30, 2018 to 5.32% for the three months ended June 30, 2019. The increase from the prior year is due primarily to higher rates on interest-earning assets due to continued increases in the Fed Funds rate for the year over year period as well as an increase in acquired loan accretion due to the Guaranty transaction. The average cost of interest-bearing liabilities increased 43 basis points to 1.70% for the three months ended June 30, 2019 compared to 1.27% for the three months ended June 30, 2018. The increase is primarily due to higher rates offered on deposits, primarily commercial money market accounts and promotional certificates of deposit, resulting from both market competition and the increased interest rates on deposit products tied to Fed Funds rates, as well as rate increases on short-term FHLB advances and junior subordinated debt. The aforementioned changes resulted in a 14 basis point increase in the net interest margin for the three months ended June 30, 2019 at 4.11% compared to 3.97% for the three months ended June 30, 2018.

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Net interest income was $251.3 million for the six months ended June 30, 2019, an increase of $98.4 million, or 64.4%, from $152.9 million for the six months ended June 30, 2018. This increase is due primarily to a $4.7 billion increase, or 61.8%, in average interest earning assets to $12.4 billion for the six months ended June 30, 2019 compared to $7.7 billion for six months ended June 30, 2018. The increases in average interest-earning assets are due to the result of the Guaranty acquisition in January 2019 and the Integrity acquisition in June 2018 as mentioned above, as well as organic growth. The net interest margin for the six months ended June 30, 2019 increased six basis points to 4.08% compared to 4.02% for the six months ended June 30, 2018. The average yield on interest earning assets increased 38 basis points from 4.87% for the six months ended June 30, 2018 to 5.25% for the six months ended June 30, 2019 while the average rate paid on interest bearing liabilities increased 47 basis points from 1.17% to 1.64% over the same period. The increase from prior year is primarily due to higher rates on interest-earning assets and liabilities due to continued increases in the Fed Funds rate for the year over year period. The primary driver was an increase in loan yields of 37 basis points, including higher loan accretion income on acquired loans due to the Guaranty acquisition in January 2019. The increase in the cost of interest-bearing liabilities is due to the higher rates offered on deposit products as discussed above as well as rate increases on short-term FHLB advances and junior subordinated debt.

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Average Balance Sheet Amounts, Interest Earned and Yield Analysis. The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three and six months ended June 30, 2019 and 2018. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances.



	Three Months Ended June 30,
	2019						2018
	Average Outstanding Balance		Interest		Yield/ Rate ⁽⁴⁾		Average Outstanding Balance		Interest		Yield/ Rate ⁽⁴⁾
(dollars in thousands)
Interest-earning assets:
Loans ⁽¹⁾	$	11,088,633	$	157,431	5.69	%	$	7,021,447	$	91,614	5.23	%
Taxable securities	776,869		5,277		2.72		605,009		3,501		2.32
Nontaxable securities	332,552		2,127		2.57		183,043		1,179		2.58
Interest-bearing deposits and other	446,075		2,828		2.54		154,986		788		2.04
Total interest-earning assets	12,644,129		167,663		5.32		7,964,485		97,082		4.89
Noninterest-earning assets	1,753,723						1,200,430
Total assets	$	14,397,852					$	9,164,915
Interest-bearing liabilities:
Checking accounts	$	3,846,970	$	10,653	1.11	%	$	2,959,101	$	6,217	0.84	%
Savings accounts	524,642		332		0.25		284,103		136		0.19
Money market accounts	2,074,568		11,041		2.13		884,630		3,889		1.76
Certificates of deposit	1,782,799		9,296		2.09		893,931		2,585		1.16
Total deposits	8,228,979		31,322		1.53		5,021,765		12,827		1.02
FHLB advances	500,330		2,984		2.39		563,875		2,847		2.03
Other borrowings and repurchase agreements	201,540		2,923		5.82		137,843		2,097		6.10
Junior subordinated debentures	53,708		791		5.91		27,736		402		5.81
Total interest-bearing liabilities	8,984,557		38,020		1.70		5,751,219		18,173		1.27
Noninterest-bearing checking accounts	3,093,478						1,973,582
Noninterest-bearing liabilities	78,305						21,578
Stockholders’ equity	2,241,512						1,418,536
Total liabilities and equity	$	14,397,852					$	9,164,915
Net interest income			$	129,643					$	78,909
Interest rate spread					3.62	%					3.62	%
Net interest margin ⁽²⁾					4.11						3.97
Net interest income and margin (tax equivalent basis) ⁽³⁾			$	130,568	4.14				$	79,324	3.99
Average interest earning assets to interest bearing liabilities					140.73						138.48

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	Six Months Ended June 30, 2019
	2019						2018
	Average Outstanding Balance		Interest		Yield/ Rate ⁽⁴⁾		Average Outstanding Balance		Interest		Yield/ Rate ⁽⁴⁾
(dollars in thousands)
Interest-earning assets:
Loans⁽¹⁾	$	10,899,746	$	302,962	5.61	%	$	6,730,278	$	174,889	5.24	%
Taxable securities	774,837		10,727		2.79		596,779		6,404		2.16
Nontaxable securities	333,757		4,352		2.63		186,219		2,372		2.57
Interest-bearing deposits and other	413,248		5,198		2.54		161,808		1,531		1.91
Total interest-earning assets	12,421,588		323,239		5.25		7,675,084		185,196		4.87
Noninterest-earning assets	1,766,074						1,187,653
Total assets	$	14,187,662					$	8,862,737
Interest-bearing liabilities:
Checking accounts	$	3,877,885	$	20,751	1.08	%	$	2,938,343	$	11,175	0.77	%
Savings accounts	514,816		656		0.26		281,849		250		0.18
Money market accounts	1,987,400		20,652		2.10		802,540		6,511		1.64
Certificates of deposit	1,720,679		17,105		2.00		878,263		4,690		1.08
Total deposits	8,100,780		59,164		1.47		4,900,995		22,626		0.93
FHLB advances	473,329		5,594		2.38		523,345		4,733		1.82
Other borrowings and repurchase agreements	193,656		5,638		5.87		137,821		4,199		6.14
Junior subordinated debentures	53,683		1,548		5.81		27,711		762		5.55
Total interest-bearing liabilities	8,821,448		71,944		1.64		5,589,872		32,320		1.17
Noninterest-bearing checking accounts	3,059,110						1,871,129
Noninterest-bearing liabilities	76,521						18,699
Stockholders’ equity	2,230,583						1,383,037
Total liabilities and equity	$	14,187,662					$	8,862,737
Net interest income			$	251,295					$	152,876
Interest rate spread					3.61	%					3.70	%
Net interest margin⁽²⁾					4.08						4.02
Net interest income and margin (tax equivalent basis) ⁽³⁾			$	253,133	4.11				$	153,746	4.04
Average interest earning assets to interest bearing liabilities					140.81						137.30

⁽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⁾A tax-equivalent adjustment has been computed using a federal income tax rate of 21% for the three and six months ended June 30, 2019 and 2018.

⁽⁴⁾Yield and rates for the three and six month periods are annualized.

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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 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 $4.7 million provision for loan losses for the three months ended June 30, 2019 compared to $2.7 million for the comparable period in 2018. Provision expense for the six months ended June 30, 2019 was $8.0 million compared to $5.4 million for the same period in 2018. Provision expense is primarily reflective of organic loan growth as well as charge-offs or specific reserves taken during the respective period. In addition, the increase is primarily a result of a specific reserve related to a commercial loan added during second quarter 2019. Net charge-offs were $169 thousand and $1.4 million for the three months ended June 30, 2019 and 2018, respectively, and $1.7 million and $1.5 million for the six months ended June 30, 2019 and 2018, respectively. The increase in net charge-offs for the six months ended June 30, 2019 was primarily related to $402 thousand in nonaccrual charge-offs in addition to a partial charge-off of an energy loan totaling $827 thousand which had been fully reserved in prior periods.

Noninterest Income

The following table sets forth the components of noninterest income for the three and six months ended June 30, 2019 and 2018 and the period-over-period variations in such categories of noninterest income:



	Three Months Ended June 30,						Variance					Six Months Ended June 30,						Variance
(dollars in thousands)	2019			2018			2019 v. 2018					2019			2018			2019 v. 2018
Noninterest Income
Service charges on deposit accounts	$	6,164		$	3,533		$	2,631		74.5	%	$	12,074		$	7,018		$	5,056		72.0	%
Investment management and trust	2,522			—			2,522			N/M		4,741			—			4,741			N/M
Mortgage banking revenue	3,702			3,609			93			2.6		6,795			7,023			(228		)	(3.2	)
Gain on sale of other real estate	312			58			254			N/M		312			118			194			N/M
Gain (loss) on sale of securities available for sale	20			(10		)	30			N/M		265			(234		)	499			N/M
Loss on sale of premises and equipment	(279		)	(89		)	(190		)	N/M		(270		)	(97		)	(173		)	N/M
Increase in cash surrender value of BOLI	1,374			758			616			81.3		2,733			1,497			1,236			82.6
Other	2,384			2,274			110			4.8		5,973			4,263			1,710			40.1
Total noninterest income	$	16,199		$	10,133		$	6,066		59.9	%	$	32,623		$	19,588		$	13,035		66.5	%

N/M - not meaningful

Total noninterest income increased $6.1 million, or 59.9% and increased $13.0 million, or 66.5% for the three and six months ended June 30, 2019 over same periods in 2018. Significant changes in the components of noninterest income are discussed below.

Service charges on deposit accounts. Service charges on deposit accounts increased $2.6 million, or 74.5% and increased $5.1 million, or 72.0% for the three and six months ended June 30, 2019, respectively, as compared to the same periods in 2018. The increase in service charge income reflects an increase in deposit accounts primarily due to the acquisition of Guaranty Bancorp in January 2019 as well as the acquisition of Integrity in June 2018.

Investment management and trust. The wealth management subsidiary and trust division were acquired in the Guaranty transaction on January 1, 2019.

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Increase in cash surrender value of BOLI. The cash surrender value of BOLI increased $616 thousand, or 81.3% and $1.2 million, or 82.6% for the three and six months ended June 30, 2019, as compared to the same periods in 2018. The increase is primarily a result of $81 million in BOLI contracts acquired in the Guaranty transaction.

Other. Other noninterest income increased $110 thousand, or 4.8% and $1.7 million, or 40.1% for the three and six months ended June 30, 2019, respectively, as compared to the same periods in 2018. The increase from prior year is primarily due to the additional accounts acquired in the Guaranty transaction as well as an increase in acquired loan recoveries during 2019.

Noninterest Expense

Noninterest expense increased $28.8 million, or 58.6% and increased $70.5 million, or 74.9% for the three and six months ended June 30, 2019 as compared to the same periods in 2018. The following table sets forth the components of the Company’s noninterest expense for the three and six months ended June 30, 2019 and 2018 and the period-over-period variations in such categories of noninterest expense:



	Three Months Ended June 30,				Variance					Six Months Ended June 30,				Variance
(dollars in thousands)	2019		2018		2019 v. 2018					2019		2018		2019 v. 2018
Noninterest Expense
Salaries and employee benefits	$	40,532	$	26,790	$	13,742		51.3	%	$	82,912	$	51,958	$	30,954		59.6	%
Occupancy	9,585		6,018		3,567			59.3		18,576		11,682		6,894			59.0
Data processing	4,449		2,467		1,982			80.3		8,218		4,872		3,346			68.7
FDIC assessment	962		712		250			35.1		2,210		1,453		757			52.1
Advertising and public relations	812		332		480			144.6		1,475		717		758			105.7
Communications	1,327		793		534			67.3		2,622		1,734		888			51.2
Other real estate owned expenses, net	79		119		(40		)	(33.6	)	150		209		(59		)	(28.2	)
Impairment of other real estate	988		—		988			N/M		1,424		85		1,339			N/M
Amortization of other intangible assets	3,235		1,393		1,842			132.2		6,470		2,724		3,746			137.5
Professional fees	1,544		1,133		411			36.3		2,714		2,252		462			20.5
Acquisition expense, including legal	3,723		3,444		279			8.1		18,710		3,989		14,721			N/M
Other	10,742		5,957		4,785			80.3		19,092		12,441		6,651			53.5
Total noninterest expense	$	77,978	$	49,158	$	28,820		58.6	%	$	164,573	$	94,116	$	70,457		74.9	%

N/M - not meaningful

Salaries and employee benefits. Salaries and employee benefits increased $13.7 million, or 51.3% and $31.0 million, or 59.6% for the three and six months ended June 30, 2019 compared to the same periods in 2018. Salaries and employee benefit expenses increased for the comparative three and six months due to additional headcount related to both the Guaranty and Integrity acquisitions as well as organic growth during the year. Salaries and benefits expense is also elevated due to severance and retention payments made or accrued totaling $4.9 million related primarily to the Guaranty transaction and our announced branch restructuring in second quarter 2019, as well as the Company's increase in the 401(k) contribution match in third quarter 2018.

Occupancy. Occupancy expenses increased $3.6 million, or 59.3% and $6.9 million, or 59.0% for the three and six months ended June 30, 2019 compared to the same periods in 2018. The increase is primarily reflective of 32 additional branches acquired in the Guaranty transaction and four branches acquired in the Integrity transaction as well as the new corporate headquarters being placed into service during the second quarter of 2019.

Data processing. Data processing expense increased $2.0 million, or 80.3% and increased $3.3 million, or 68.7% for the three and six months ended June 30, 2019 compared to the same periods in 2018. Data processing increased due to additional branches and accounts acquired with the Guaranty and Integrity acquisitions.

Impairment of other real estate. The increase in impairment of other real estate is primarily a result of impairments taken on the closed branches related to our branch restructure in second quarter of 2019.

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Amortization of other intangible assets. Intangible amortization increased $1.8 million, or 132.2% and $3.7 million, or 137.5% for the three and six months ended June 30, 2019 compared to the same periods in 2018. The increase relates to the additional amortization of core deposit and customer intangibles related to the acquisition of Guaranty and Integrity transactions.

Acquisition expenses. Acquisition expenses increased $279 thousand and $14.7 million for the three and six months ended June 30, 2019 compared to the same periods in 2018. The increase in acquisition expenses compared to the same period in 2018 was primarily due to $8.7 million in change in control payments to Guaranty executives as well as an increase in professional fees, contract termination fees, and conversion-related expenses related to Guaranty.

Other noninterest expense. Other noninterest expense increased $4.8 million, or 80.3% and $6.7 million, or 53.5% for the three and six months ended June 30, 2019 compared to the same periods in 2018. The increase in noninterest expense primarily reflects the additional headcount, branch locations and accounts acquired in the Guaranty and Integrity transactions but also due to higher deposit- and loan-related expenses for the year over year period. In addition, we recorded a $1.4 million loss contingency reserve related to chargebacks on a merchant card deposit account acquired with Guaranty during second quarter 2019.

Income Tax Expense

Income tax expense was $13.4 million and $24.5 million for the three and six months ended June 30, 2019, respectively, and $7.5 million and $14.3 million for the same period in 2018. The effective tax rates were 21.2% and 22.0% for the three and six months ended June 30, 2019, respectively, compared to 20.2% and 19.6% for the same period in 2018. The higher effective tax rates in 2019 were due to $1.4 million in deductibility limitations related to the change in control payments made to Guaranty employees and nondeductible acquisition expenses in addition to increased state income tax expense.

Discussion and Analysis of Financial Condition

The following is a discussion and analysis of the Company’s financial condition as of June 30, 2019 and December 31, 2018.

Assets

The Company’s total assets increased by $4.9 billion, or 49.3%, to $14.7 billion as of June 30, 2019 from $9.8 billion at December 31, 2018. The increase is primarily due to $3.9 billion in assets acquired with Guaranty acquisition, as well as organic growth for the period.

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Loan Portfolio

The following table presents the balance and associated percentage of each major category in our loan portfolio as of June 30, 2019 and December 31, 2018:




(dollars in thousands)	June 30, 2019					December 31, 2018
Commercial ⁽¹⁾	$	2,220,172		19.6	%	$	1,361,104		17.2	%
Real estate:
Commercial	5,831,466			51.4		4,141,356			52.3
Commercial construction, land and land development	1,164,789			10.3		905,421			11.4
Residential⁽²⁾	1,573,467			13.9		1,082,248			13.7
Single family interim construction	379,422			3.3		331,748			4.2
Agricultural	107,685			0.9		66,638			0.8
Consumer ⁽²⁾	66,432			0.6		31,759			0.4
Other	589			—		253			—
	11,344,022			100.0	%	7,920,527			100.0	%
Deferred loan fees	(2,581		)			(3,303		)
Allowance for loan losses	(51,075		)			(44,802		)
Total loans, net	$	11,290,366				$	7,872,422

⁽¹⁾ Includes mortgage warehouse purchase loans of $453.5 million and $170.3 million at June 30, 2019 and December 31, 2018, respectively.

⁽²⁾Includes residential real estate loans held for sale as of June 30, 2019 and December 31, 2018 of $74.1 million and $32.7 million, respectively, and consumer loans held for sale at June 30, 2019 of $32.4 million.

Our loan portfolio is the largest category of our earning assets. As of June 30, 2019 and December 31, 2018, total loans, net of allowance for loan losses and deferred fees, totaled $11.3 billion and $7.9 billion, respectively, which is an increase of 43.4% between the two dates. The increase is primarily due to $2.8 billion in loans acquired in the Guaranty acquisition but also due to organic loan growth during 2019.

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 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. 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.

Real estate the Company has acquired as a result of foreclosure or by deed-in-lieu-of foreclosure is classified as other real estate owned until sold. The Company's policy is to initially record other real estate owned 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 or internal valuations of the other real estate.

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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)	June 30, 2019			December 31, 2018
Nonaccrual loans
Commercial	$	9,510		$	5,224
Real estate:
Commercial real estate, construction, land and land development	4,685			1,329
Residential real estate	1,284			1,775
Single family interim construction	—			3,578
Consumer	38			32
Total nonaccrual loans ⁽¹⁾	15,517			11,938
Loans delinquent 90 days or more and still accruing
Commercial	845			—
Consumer	—			5
Total loans delinquent 90 days or more and still accruing	845			5
Troubled debt restructurings, not included in nonaccrual loans
Commercial	—			114
Real estate:
Commercial real estate, construction, land and land development	378			405
Residential real estate	164			168
Total troubled debt restructurings, not included in nonaccrual loans	542			687
Total nonperforming loans	16,904			12,630
Other real estate owned and other repossessed assets:
Commercial real estate, construction, land and land development	10,972			4,200
Consumer	123			114
Total other real estate owned and other repossessed assets	11,095			4,314
Total nonperforming assets	$	27,999		$	16,944
Ratio of nonperforming loans to total loans held for investment ⁽²⁾	0.16		%	0.16		%
Ratio of nonperforming assets to total assets	0.19			0.17


⁽¹⁾	Nonaccrual loans include troubled debt restructurings of $716 thousand and $506 thousand at June 30, 2019 and December 31, 2018, respectively and excludes loans acquired with deteriorated credit quality of $12.5 million and $7.0 million as of June 30, 2019 and December 31, 2018, respectively.


⁽²⁾	Excluding mortgage warehouse purchase loans of $453.5 million and $170.3 million as of June 30, 2019 and December 31, 2018, respectively.

Nonaccrual loans increased to $15.5 million at June 30, 2019 from $11.9 million as of December 31, 2018. Troubled debt restructurings that were not on nonaccrual status totaled $542 thousand at June 30, 2019 decreasing slightly from $687 thousand at December 31, 2018. The increase in nonaccrual loans was primarily due to the addition of three commercial loans totaling $4.8 million and two commercial real estate loans totaling $3.4 million offset by payoffs of two nonaccrual single-family interim construction loans and one commercial real estate loan totaling $3.9 million, as well as nonaccrual charge-offs totaling $402 thousand and a $544 thousand nonaccrual residential real estate loan placed in foreclosure during the six months ended June 30, 2019. The net increase in other real estate owned and repossessed assets is primarily due to the transfer of six former branch properties to other real estate owned which were recorded at $7.3 million at date of transfer as well as one property recorded at $300 thousand acquired with the Guaranty transaction, offset by impairments of $872 thousand.

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As of June 30, 2019, the Company had a total of 136 substandard and doubtful loans with an aggregate principal balance of $56.3 million that were not currently impaired loans, nonaccrual loans, 90 days past due loans 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 loans 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 June 30, 2019, the allowance for loan losses amounted to $51.1 million, or 0.47% of total loans held for investment, excluding mortgage warehouse purchase loans, compared with $44.8 million, or 0.58% as of December 31, 2018. The dollar increase from year end is primarily due to additional general reserves for organic loan growth as well as a specific reserve taken on a commercial loan during the second quarter. The decrease in the allowance for loan losses as a percentage of loans reflects that loans acquired in the Guaranty transaction were recorded at fair value without an allowance at acquisition date. As of June 30, 2019, the discount on acquired loans totaled $115.5 million.

The allowance for loan losses to nonperforming loans has decreased slightly from 354.73% at December 31, 2018 to 302.15% at June 30, 2019. Nonperforming loans have increased to $16.9 million at June 30, 2019 compared to $12.6 million at December 31, 2018.

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 $20 thousand and $265 thousand on the sale of securities for the three and six months ended June 30, 2019 and a net loss of $10 thousand and $234 thousand on the sale of securities for the three and six month ended June 30, 2018. Securities represented 7.5% and 7.0% of the Company’s total assets at June 30, 2019 and December 31, 2018, respectively.

Management evaluates securities for other-than-temporary impairment (OTTI) on at least a quarterly basis and more frequently when economic or 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 June 30, 2019 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 June 30, 2019, is temporary and no other-than-temporary impairment has been realized in the Company’s consolidated financial statements.

Capital Resources and Regulatory Capital Requirements

Total stockholder’s equity was $2.2 billion at June 30, 2019 compared with $1.6 billion at December 31, 2018, an increase of approximately $642.9 million. The increase was primarily due to stock issued in the Guaranty acquisition for a total, net of offering costs, of $601.1 million, net income of $86.9 million earned by the Company during the six months ended June 30, 2019, stock based compensation of $3.9 million, and an increase of $25.4 million in unrealized gain (loss) on available for sale securities offset by a cumulative adjustment for change in accounting principles of $926 thousand, stock repurchased by the Company totaling $51.6 million and dividends paid of $21.8 million.

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As of June 30, 2019, the Company exceeded all capital ratio requirements under prompt corrective action and other regulatory requirements, as detailed in the table below:



	As of June 30, 2019
	Actual Consolidated		Actual Bank		Required minimum capital - Basel III fully phased-in		Required to be considered well capitalized (Bank only)
	Ratio		Ratio		Ratio		Ratio
Tier 1 capital to average assets ratio	9.06	%	10.55	%	4.00	%	≥5.00%
Common equity tier 1 capital to risk weighted assets ratio	9.24		11.25		7.00		≥6.50
Tier 1 capital to risk weighted assets ratio	9.69		11.25		8.50		≥8.00
Total capital to risk weighted assets ratio	11.54		11.66		10.50		≥10.00

Share Repurchase Program. The Company established share repurchase programs in prior years which would allow the Company to purchase its common stock in the open market or in privately negotiated transactions. In general, share repurchase programs allow the Company to proactively manage its capital position and return excess capital to shareholders. On October 24, 2018, the Company announced the reestablishment of its share repurchase program. The program authorizes the purchase by the Company of up to $75 million of its common stock. The repurchase program is authorized to continue through October 1, 2019. As of June 30, 2019, the Company repurchased a total of 897,738 shares of Company stock at a total cost of $49 million under this program.

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, the Company maintains correspondent relationships with other banks in order to sell loans or purchase overnight funds should additional liquidity be needed. As of June 30, 2019, the Company had established federal funds lines of credit with 11 unaffiliated banks totaling $430 million with no borrowings against the lines at that time. The Company also participates in an exchange that provides direct overnight borrowings with other financial institutions with a borrowing capacity of $419 million with none outstanding as of June 30, 2019. The Company has an unsecured line of credit totaling $100 million with an unrelated commercial bank. The line had $35.0 million outstanding as of June 30, 2019. Based on the values of stock, securities, and loans pledged as collateral, as of June 30, 2019, the Company had additional borrowing capacity with the FHLB of $3.4 billion. In addition, the Company maintains a secured line of credit with the Federal Reserve Bank with an availability to borrow $972.9 million at June 30, 2019.

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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.

As a result of the acquisition of Guaranty completed during the six months ended June 30, 2019, the Company acquired deposit accounts, FHLB advances, subordinated debt commitments, junior subordinated debentures and assumed the operating lease commitments for several branch locations acquired in the Guaranty transaction.

Other than normal changes in the ordinary course of business and the items mentioned above, there have been no significant changes in the types of contractual obligations or amounts due since December 31, 2018.

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 $2.4 billion and $24.4 million, respectively, as of June 30, 2019. 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 its estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

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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 difference in the initial fair value and unpaid principal balance (the discount) recognized as interest income on a level yield basis over the life of the loan. The Company accounts for the nonperforming 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 with no valuation allowance.

For purchase credit impaired loans, 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.

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Goodwill and Other Intangible Assets. 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. The Company first assesses 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, then performing a two step impairment test is unnecessary. 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, 2018 that would indicate any impairment has occurred, therefore, management does not believe goodwill is impaired as of June 30, 2019.

Core deposit intangibles and other acquired customer relationship intangibles 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. Other intangible assets are being amortized on a straight-line basis over their estimated useful lives ranging from ten to thirteen years. Other intangible assets 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.

Future Application of Pending Accounting Standards.

In June 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) (ASU 2016-13). The ASU introduces a new credit loss methodology, the current expected credit loss (CECL) model, which requires the recognition of an allowance for lifetime expected credit losses on loans, held-to-maturity debt securities and other receivables measured at amortized cost at the time the financial asset is originated or acquired. Credit losses will be immediately recognized through net income; the amount recognized will be based on the current estimate of contractual cash flows not expected to be collected over the financial asset’s contractual term. The CECL model is expected to result in more timely recognition of credit losses. ASU 2016-13 also amends the credit loss measurement guidance for available for sale debt securities and requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities. Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. ASU 2016-13 will be effective for the Company on January 1, 2020. The Company continues to evaluate the impact adoption of ASU 2016-13 will have on its consolidated financial statements and disclosures. The CECL methodology represents a significant change from the existing US GAAP of an "incurred loss" model, which encompasses allowances for current known and inherent losses within the portfolio, and while the Company is currently unable to reasonably estimate the impact of adopting ASU 2016-13, the Company expects that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date. To implement this new accounting standard, the Company established a steering committee and working group that includes individuals from various functional areas and is currently working through its implementation plan which includes such things as assessment and documentation of processes, internal controls and data sources; model development and documentation; and system configuration. Early implementation activities focused on data capture and portfolio segmentation. Substantial progress has been made on model development with parallel runs beginning in early third quarter and validation of the reasonable and supportable forecast model and primary model/tool also to be completed during the third quarter.

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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 Independent Bank's asset and liability management function, which is managed by the Company's Treasurer. The 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 the Company.

The Company's management and the Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit the Company's 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 and 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.

The Company also analyzes 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 the Company's future earnings and is used in conjunction with the analyses on net interest income.

The Company conducts periodic analyses of its sensitivity to interest rate risks through the use of a third-party proprietary interest-rate sensitivity model. That model has been customized to the Company's specifications. The analyses conducted by use of that model are based on current information regarding the Company's actual interest-earnings assets, interest-bearing liabilities, capital and other financial information that it supplies. The third party uses that information in the model to estimate the Company's sensitivity to interest rate risk.

The Company's interest rate risk model indicated that it was in a balanced rate sensitive position in terms of interest rate sensitivity as of June 30, 2019. 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 June 30, 2019:



Hypothetical Shift in Interest Rates (in bps)	% Change in Projected Net Interest Income
200	0.20%
100	0.15
(100)	0.32

These are good faith estimates and assume that the composition of the Company's 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 the Company might undertake in response to changes in market interest rates. The Company believes 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, the Company anticipates 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 its Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company's 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.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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, in a case styled Peggy Roif Rotstain, et al. on behalf of themselves and all others similarly situated, v. Trustmark National Bank, et al., Civil Action No. 3:09-CV-02384-N-BG. The suit alleges, among other things, that the plaintiffs were victims of fraud by SIBL and other Stanford Entities and seeks 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. The plaintiffs seek recovery from Independent Bank and other defendants for their losses. The case was inactive due to a court-ordered discovery stay issued March 2, 2015 pending the Court’s ruling on plaintiff’s motion for class certification and designation of class representatives and counsel. On November 7, 2017, the Court issued an order denying the plaintiff’s motion. In addition, the Court lifted the previously ordered discovery stay. On January 11, 2018, the Court entered a scheduling order providing that the case be ready for trial on January 27, 2020. However, discovery in this case has been extended and the Company now expects that the trial will be delayed until sometime after May 2020. The Company has experienced an increase in legal fees associated with the defense of this claim and anticipates further increases in legal fees as the case proceeds to trial.

Independent Bank notified its insurance carriers of the claims made in the Second Amended Complaint. The insurance carriers initially indicated that the claims were not covered by the policies or that a “loss” has not yet occurred. Independent Bank pursued insurance coverage as well as reimbursement of defense costs through the initiation of litigation and other means. On November 6, 2018, the Company settled claims under its Financial Institutions Select Policy pursuant to which the Company received payment of an amount which is not material to the operations of the Company. The Company did not settle any claims under its Financial Institution Bond Policy.

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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, 2018, and in the information contained in this Quarterly Report on Form 10-Q and our other reports and registrations statements.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

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		Amended and Restated Certificate of Formation of Independent Bank Group, Inc., which is incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 of Independent Bank Group, Inc. filed with the SEC on February 27, 2013 (Registration No. 333 186912) (the "S-1 Registration Statement")

Exhibit 3.2		Certificate of Amendment to Amended and Restated Certificate of Formation of Independent Bank Group, Inc., which is incorporated herein by reference to Exhibit 3.3 to Amendment No. 2 to the Company’s S-1 Registration Statement filed with the SEC on April 1, 2013

Exhibit 3.3		Third Amended and Restated Bylaws of Independent Bank Group, Inc., which are incorporated herein by reference to Exhibit 3.2 to Amendment No. 1 to the Company’s S-1 Registration Statement filed with the SEC on March 18, 2013

Exhibit 3.4		Statement of Designations of Senior Non-Cumulative Perpetual Preferred Stock, Series A of Independent Bank Group, Inc., as filed with the Office of the Secretary of State of the State of Texas on April 15, 2014, which is incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on April 17, 2014

Exhibit 3.5		Certificate of Merger, dated January 2, 2014, of Live Oak Financial Corp. with and into Independent Bank Group, Inc., which is incorporated herein by reference to Exhibit 3.5 to Amendment No. 1 to the Company’s Registration Statement on Form S-3 (Registration No. 333-196627) filed with the SEC on June 25, 2014 (the “S-3 Registration Statement”)

Exhibit 3.6		Certificate of Merger, dated April 15, 2014, of BOH Holdings, Inc. with and into Independent Bank Group, Inc., which is incorporated herein by reference to Exhibit 3.6 to Amendment No. 1 to the S-3 Registration Statement filed with the SEC on June 25, 2014

Exhibit 3.7		Certificate of Merger, dated September 30, 2014, of Houston City Bancshares, Inc. with and into Independent Bank Group, Inc., which is incorporated by reference to Exhibit 3.7 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, filed with the SEC on July 31, 2015

Exhibit 3.8		Certificate of Merger, dated March 31, 2017, of Carlile Bancshares, Inc. with and into Independent Bank Group, Inc. which is incorporated by reference to Exhibit 3.8 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, filed with the SEC on April 27, 2017

Exhibit 3.9		Certificate of Merger, dated October 23, 2017, of Washington Investment Company with and into Independent Bank Group, Inc., which is incorporated by reference to Exhibit 3.9 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, filed with the SEC on July 26, 2018

Exhibit 3.10		Certificate of Merger, dated May 31, 2018, of Integrity Bancshares, Inc. with and into Independent Bank Group, Inc., which is incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, filed with the SEC on July 26, 2018

Exhibit 3.11		Certificate of Merger, dated December 27, 2018, but effective January 1, 2019, of Guaranty Bancorp with and into Independent Bank Group, Inc., which is incorporated by reference to Exhibit 3.10 to the Company's Annual Report on Form 10-K for the year December 31, 2018, filed with the SEC on February 28, 2019

Exhibit 4.1		Form of certificate representing shares of the Company’s common stock, which is incorporated herein by reference to Exhibit 4.1 to Amendment No. 1 to the Form S-1 Registration Statement filed with the SEC on March 18, 2013

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Exhibit 4.2		Form of Common Stock Purchase Warrant, with schedules of differences, which is incorporated herein by reference to Exhibit 4.2 to the S-1 Registration Statement

Exhibit 4.3		Subordinated Debt Indenture, dated as of June 25, 2014, between Independent Bank Group, Inc. and Wells Fargo Bank, National Association, in its capacity as Indenture Trustee, which is incorporated herein by reference to Exhibit 4.6 to Amendment No. 1 to the S‑3 Registration Statement filed with the SEC on June 25, 2014

Exhibit 4.4		First Supplemental Indenture, dated as of July 17, 2014, between Independent Bank Group, Inc. and Wells Fargo Bank Shareowner Services, in its capacity as Indenture Trustee, which is incorporated herein by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K, dated July 17, 2014

Exhibit 4.5		Second Supplemental Indenture, dated as of December 19, 2017, between Independent Bank Group, Inc. and Wells Fargo Bank, National Association, as trustee, which is incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8‑K, dated December 19, 2017

Exhibit 4.6		Form of Global Note to represent the 5.875% Subordinated Notes due August 1, 2024, of the Company, which is incorporated herein by reference to Exhibit 4.5 in the Company’s Quarterly Report on Form 10‑Q, for the quarter ended September 30, 2017, filed with the SEC on October 26, 2017

Exhibit 4.7		Form of Global Note to represent the 5.875% Subordinated Notes due August 1, 2024, of the Company, which is incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K, dated June 22, 2016

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

Exhibit 4.8(a)*		Independent Bank 401(k) Profit Sharing Plan

Exhibit 4.8(b)		Amendment to Independent Bank 401(k) Profit Sharing Plan for Unilateral Interim Amendment to Comply with the 2017 Final Regulations under ERISA Section 503, dated June 6, 2018, which is incorporated by reference to Exhibit 4.8(b) to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2019, filed with the SEC on April 25, 2019

Exhibit 4.8(c)		Amendment to Independent Bank 401(k) Profit Sharing Plan for Interim Amendment to Comply with the Final Regulations under Code Sections 401(k) and 401(m), dated October 16, 2018, which is incorporated by reference to Exhibit 4.8(c) to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2019, filed with the SEC on April 25, 2019

Exhibit 4.8(d)		Amendment to Independent Bank 401(k) Profit Sharing Plan for Amendment to Comply with the Bipartisan Budget Act of 2018, dated December 21, 2018, which is incorporated by reference to Exhibit 4.8(d) to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2019, filed with the SEC on April 25, 2019

Exhibit 31.1*		Chief Executive Officer Section 302 Certification

Exhibit 31.2*		Chief Financial Officer Section 302 Certification

Exhibit 32.1**		Chief Executive Officer Section 906 Certification

Exhibit 32.2**		Chief Financial Officer Section 906 Certification

Exhibit 101.INS *		XBRL Instance Document-the XBRL Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.

Exhibit 101.SCH *		XBRL Taxonomy Extension Schema Document

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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.



**	Furnished herewith (such certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates it by reference)

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:	July 25, 2019	By: /s/ David R. Brooks

		David R. Brooks
		Chairman, Chief Executive Officer and President



Date:	July 25, 2019	By: /s/ Michelle S. Hickox

		Michelle S. Hickox
		Executive Vice President
		Chief Financial Officer