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Independent Bank Group, Inc. - Quarter Report: 2020 March (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 March 31, 2020.
or
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from                 to                    .
Commission file number 001-35854
Independent Bank Group, Inc.
(Exact name of registrant as specified in its charter)   
Texas
   
13-4219346
(State or other jurisdiction of incorporation or organization)
   
(I.R.S. Employer Identification No.)
   
   
   
7777 Henneman Way
   
 
McKinney,
 
 
Texas
 
75070-1711
(Address of principal executive offices)
   
(Zip Code)
(972) 562-9004
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
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 – 43,041,776 shares as of April 30, 2020.





INDEPENDENT BANK GROUP, INC. AND SUBSIDIARIES
Form 10-Q
March 31, 2020
   
PART I.
 
 
   
   
   
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   
   
 
 
Item 2.
 
   
   
   
 
Item 3.
 
   
   
   
 
Item 4.
 
   
   
   
 
PART II.
 
 
   
   
   
 
Item 1.
   
   
   
   
 
Item 1A.
   
   
   
   
 
Item 2
   
   
   
   
 
Item 3.
   
   
   
   
 
Item 4.
   
   
   
 
 
Item 5.
   
   
   
   
 
Item 6.
   
   
   
   
 
   
 
 
   


***






Table of Contents

PART I
ITEM 1. CONSOLIDATED FINACIAL STATEMENTS
Independent Bank Group, Inc. and Subsidiaries
Consolidated Balance Sheets
March 31, 2020 (unaudited) and December 31, 2019
(Dollars in thousands, except share information)
   
 
March 31,
 
December 31,
Assets
 
2020
 
2019
Cash and due from banks
 
$
203,572

 
$
186,299

Interest-bearing deposits in other banks
 
745,335

 
378,871

Cash and cash equivalents
 
948,907

 
565,170

Certificates of deposit held in other banks
 
5,719

 
5,719

Securities available for sale, at fair value
 
1,089,136

 
1,085,936

Loans held for sale (includes $32,736 and $29,204 carried at fair value, respectively)
 
39,427

 
35,645

Loans, net
 
11,758,272

 
11,562,814

Premises and equipment, net
 
245,539

 
242,874

Other real estate owned
 
2,994

 
4,819

Federal Home Loan Bank (FHLB) of Dallas stock and other restricted stock
 
55,325

 
30,052

Bank-owned life insurance (BOLI)
 
216,422

 
215,081

Deferred tax asset
 
1,616

 
6,943

Goodwill
 
994,021

 
994,021

Other intangible assets, net
 
97,565

 
100,741

Other assets
 
118,925

 
108,392

Total assets
 
$
15,573,868

 
$
14,958,207

 
 
 
 
 
Liabilities and Stockholders’ Equity
 
   
 
   
Deposits:
 
   
 
   
Noninterest-bearing
 
$
3,156,270

 
$
3,240,185

Interest-bearing
 
8,726,496

 
8,701,151

Total deposits
 
11,882,766

 
11,941,336

FHLB advances
 
975,000

 
325,000

Other borrowings
 
177,860

 
202,251

Junior subordinated debentures
 
53,874

 
53,824

Other liabilities
 
98,083

 
96,023

Total liabilities
 
13,187,583

 
12,618,434

Commitments and contingencies
 


 


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

 

Common stock (43,041,776 and 42,950,228 shares outstanding, respectively)
 
430

 
430

Additional paid-in capital
 
1,928,241

 
1,926,359

Retained earnings
 
426,942

 
393,674

Accumulated other comprehensive income
 
30,672

 
19,310

Total stockholders’ equity
 
2,386,285

 
2,339,773

Total liabilities and stockholders’ equity
 
$
15,573,868

 
$
14,958,207

See Notes to Consolidated Financial Statements

1





Table of Contents

Independent Bank Group, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended March 31, 2020 and 2019 (unaudited)
(Dollars in thousands, except per share information)
   
 
Three Months Ended March 31,
   
 
2020
 
2019
Interest income:
 
 
 
 
Interest and fees on loans
 
$
147,105

 
$
145,531

Interest on taxable securities
 
5,164

 
5,450

Interest on nontaxable securities
 
2,065

 
2,225

Interest on interest-bearing deposits and other
 
2,071

 
2,370

Total interest income
 
156,405

 
155,576

Interest expense:
 
 
 
 
Interest on deposits
 
28,071

 
27,842

Interest on FHLB advances
 
1,626

 
2,610

Interest on other borrowings and repurchase agreements
 
2,795

 
2,715

Interest on junior subordinated debentures
 
672

 
757

Total interest expense
 
33,164

 
33,924

Net interest income
 
123,241

 
121,652

Provision for loan losses
 
8,381

 
3,224

Net interest income after provision for loan losses
 
114,860

 
118,428

Noninterest income:
 
 
 
 
Service charges on deposit accounts
 
5,542

 
5,910

Investment management and trust
 
1,986

 
2,219

Mortgage banking revenue
 
2,525

 
3,093

Loss on sale of loans
 
(42
)
 

Gain on sale of other real estate
 
25

 

Gain on sale of securities available for sale
 
356

 
245

(Loss) gain on sale and disposal of premises and equipment
 
(63
)
 
9

Increase in cash surrender value of BOLI
 
1,341

 
1,359

Other
 
2,841

 
3,589

Total noninterest income
 
14,511

 
16,424

Noninterest expense:
 
 
 
 
Salaries and employee benefits
 
38,660

 
42,380

Occupancy
 
10,037

 
8,991

Communications and technology
 
5,552

 
5,064

FDIC assessment
 
1,752

 
1,248

Advertising and public relations
 
611

 
663

Other real estate owned expenses, net
 
374

 
71

Impairment of other real estate
 

 
436

Amortization of other intangible assets
 
3,176

 
3,235

Professional fees
 
4,214

 
1,170

Acquisition expense, including legal
 
549

 
14,987

Other
 
9,443

 
8,350

Total noninterest expense
 
74,368

 
86,595

Income before taxes
 
55,003

 
48,257

Income tax expense
 
10,836

 
11,126

Net income
 
$
44,167

 
$
37,131

Basic earnings per share
 
$
1.03

 
$
0.85

Diluted earnings per share
 
$
1.03

 
$
0.85

See Notes to Consolidated Financial Statements

2





Table of Contents

Independent Bank Group, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2020 and 2019 (unaudited)
(Dollars in thousands)
   
 
Three Months Ended March 31,
   
 
2020
 
2019
Net income
 
$
44,167

 
$
37,131

Other comprehensive income before tax:
 
   

 
 
Change in net unrealized gains on available for sale securities during the year
 
14,976

 
15,151

Reclassification for amount realized through sales of securities available for sale included in net income
 
(356
)
 
(245
)
Other comprehensive income before tax
 
14,620

 
14,906

Income tax expense
 
3,258

 
3,130

Other comprehensive income, net of tax
 
11,362

 
11,776

Comprehensive income
 
$
55,529

 
$
48,907

See Notes to Consolidated Financial Statements
   

3






Independent Bank Group, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
Three Months Ended March 31, 2020 and 2019 (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 Income (Loss)
 
Total
   
 
Shares
 
Amount
 
Balance, December 31, 2019
$

 
42,950,228

 
$
430

 
$
1,926,359

 
$
393,674

 
$
19,310

 
$
2,339,773

Net income

 

 

 

 
44,167

 

 
44,167

Other comprehensive income, net of tax

 

 

 

 

 
11,362

 
11,362

Common stock repurchased

 
(2,629
)
 

 

 
(145
)
 

 
(145
)
Restricted stock granted

 
94,177

 

 

 

 

 

Stock based compensation expense

 

 

 
1,882

 

 

 
1,882

Cash dividends ($0.25 per share)

 

 

 

 
(10,754
)
 

 
(10,754
)
Balance, March 31, 2020
$

 
43,041,776

 
$
430

 
$
1,928,241

 
$
426,942

 
$
30,672

 
$
2,386,285

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2018
$

 
30,600,582

 
$
306

 
$
1,317,616

 
$
296,816

 
$
(8,305
)
 
$
1,606,433

Cumulative effect of change in accounting principle

 

 

 

 
(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

See Notes to Consolidated Financial Statements 

4




 

Independent Bank Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2020 and 2019 (unaudited)
(Dollars in thousands) 

   
 
Three Months Ended March 31,
   
 
2020
 
2019
Cash flows from operating activities:
 
   
 
   
Net income
 
$
44,167

 
$
37,131

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation expense
 
3,154

 
2,694

Accretion of income recognized on acquired loans
 
(9,142
)
 
(9,086
)
Amortization of other intangibles assets
 
3,176

 
3,235

Amortization of premium on securities, net
 
619

 
800

Amortization of discount and origination costs on borrowings
 
159

 
159

Stock based compensation expense
 
1,882

 
2,172

Excess tax expense (benefit) on restricted stock vested
 
80

 
(20
)
FHLB stock dividends
 
(168
)
 
(191
)
Gain on sale of securities available for sale
 
(356
)
 
(245
)
Loss (gain) on sale and disposal of premises and equipment
 
63

 
(9
)
Loss on sale of loans
 
42

 

Gain on sale of other real estate owned
 
(25
)
 

Impairment of other real estate
 

 
436

Deferred tax expense
 
2,471

 
6,618

Provision for loan losses
 
8,381

 
3,224

Increase in cash surrender value of BOLI
 
(1,341
)
 
(1,359
)
Net gain on mortgage loans held for sale
 
(3,916
)
 
(2,799
)
Originations of loans held for sale
 
(107,580
)
 
(74,640
)
Proceeds from sale of loans held for sale
 
107,714

 
87,568

Net change in other assets
 
(10,935
)
 
(1,680
)
Net change in other liabilities
 
1,980

 
(16,402
)
Net cash provided by operating activities
 
40,425

 
37,606

Cash flows from investing activities:
 
   
 
   
Proceeds from maturities, calls and pay downs of securities available for sale
 
1,528,836

 
1,128,949

Proceeds from sale of securities available for sale
 
13,100

 
185,508

Purchases of securities available for sale
 
(1,530,779
)
 
(1,129,986
)
Purchases of FHLB stock and other restricted stock
 
(25,211
)
 
(2,606
)
Proceeds from redemptions of FHLB stock and other restricted stock
 
106

 
26,000

Proceeds from sale of loans
 
1,455

 

Net loans originated held for investment
 
(89,252
)
 
(180,233
)
Originations of mortgage warehouse purchase loans
 
(4,523,819
)
 
(1,579,008
)
Proceeds from pay-offs of mortgage warehouse purchase loans
 
4,414,527

 
1,498,040

Additions to premises and equipment
 
(5,948
)
 
(11,601
)
Proceeds from sale of premises and equipment
 
66

 
9

Proceeds from sale of other real estate owned
 
4,200

 

Cash acquired in connection with acquisition
 

 
39,913

Cash paid in connection with acquisition
 

 
(9
)
Net cash used in investing activities
 
(212,719
)
 
(25,024
)

5




 

Independent Bank Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Continued)
Three Months Ended March 31, 2020 and 2019 (unaudited)
(Dollars in thousands) 

   
 
Three Months Ended March 31,
   
 
2020
 
2019
Cash flows from financing activities:
 
   

 
   

Net (decrease) increase in demand deposits, money market and savings accounts
 
(9,596
)
 
274,844

Net (decrease) increase in time deposits
 
(48,974
)
 
109,503

Proceeds from FHLB advances
 
1,100,000

 
700,000

Repayments of FHLB advances
 
(450,000
)
 
(792,653
)
Proceeds from other borrowings
 

 
21,000

Repayments of other borrowings
 
(24,500
)
 

Repurchase of common stock
 
(145
)
 
(12,507
)
Offering costs paid in connection with acquired bank
 

 
(804
)
Dividends paid
 
(10,754
)
 
(10,945
)
Net cash provided by financing activities
 
556,031

 
288,438

Net change in cash and cash equivalents
 
383,737

 
301,020

Cash and cash equivalents at beginning of period
 
565,170

 
130,779

Cash and cash equivalents at end of period
 
$
948,907

 
$
431,799

See Notes to Consolidated Financial Statements



6






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)


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.
Proposed merger with Texas Capital Bancshares, Inc.: The Company and Texas Capital Bancshares, Inc. (TCBI) and its subsidiary, Texas Capital Bank, have entered into an Agreement and Plan of Merger, dated as of December 9, 2019, which is referred to as the "merger agreement". Under the merger agreement, the Company and TCBI have agreed to combine their respective companies in an all stock merger of equals, pursuant to which TCBI will merge with and into the Company, with the Company continuing as the surviving entity, in a transaction referred to as "the merger." Immediately following the merger, Texas Capital Bank will merge with and into Independent Bank, with Independent Bank as the surviving bank. The combined holding company will operate under the Company name, Independent Bank Group, Inc. The name of the combined bank will be Texas Capital Bank and will operate under the name Independent Financial in Colorado and Texas Capital Bank in Texas.
Under the terms of the merger agreement, TCBI shareholders will receive 1.0311 shares of the Company's common stock for each share of TCBI common stock based on a fixed exchange ratio. Following the completion of the merger, the Company estimates that former holders of TCBI common stock will own approximately fifty-five percent (55%) and holders of the Company common stock will own approximately forty-five percent (45%) of the common stock of the combined company. In addition, each share of TCBI series A preferred stock issued and outstanding immediately prior to the effective time of the merger will be converted into the right to receive one (1) share of the Company's series B preferred stock having substantially the same terms as the TCBI series A preferred stock.
The merger agreement was unanimously approved by the boards of directors of both companies and is anticipated to close in mid-2020, although delays may occur. The transaction is subject to receipt of regulatory approvals and satisfaction of other customary closing conditions, including approval of both Independent Bank Group and TCBI shareholders.
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.
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 Form 10-K, as amended, for the year ended December 31, 2019. The consolidated balance sheet at December 31, 2019 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.
Accounting standards codification: The Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) is the officially recognized source of authoritative U.S. generally accepted accounting principles (GAAP) applicable to all public and non-public non-governmental entities. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.

7






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

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.
Use of estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Accordingly, actual results could differ from those estimates. The material estimates included in the financial statements relate to the allowance for loan losses, the valuation of goodwill and valuation of assets and liabilities acquired in business combinations.
Adoption of new accounting standards: ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 along with several other subsequent codification updates related to accounting for credit losses, requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the credit loss measurement guidance for available for sale debt securities and purchased financial assets with credit deterioration. Under prior US GAAP, companies generally recognized credit losses when it was probable that the loss has been incurred (incurred loss model). ASU 2016-13 requires 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. ASU 2016-13 became effective for the Company on January 1, 2020.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed by the President of the United States that included an option for financial institutions to delay the implementation of ASU 2016-13 until the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. Due to the uncertainty of the economic forecast resulting from the coronavirus (COVID-19) pandemic and the potential impact of the government economic stimulus measures, the Company has determined to delay its implementation of ASU 2016-13 and has calculated and recorded its provision for loan losses under the incurred loss model that existed prior to ASU 2016-13.
Upon adoption of ASU 2016-13 with an effective retrospective implementation date of January 1, 2020, the Company expects to increase its combined allowance for loan losses and reserves for unfunded commitments by approximately $80,000, of which $22,000 is attributable to purchase credit deteriorated loans. The Company will apply the standard's provisions as a cumulative-effect adjustment to retained earnings. The expected increase in the allowance for loan losses is a result of changing from an incurred loss model, which encompasses allowances for current known and inherent losses within the portfolio, to a CECL model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The majority of the increase is attributable to applying the CECL model to the Company's acquired loans, which, under prior guidance, were recorded at fair value without an allowance at acquisition date. Furthermore, ASU 2016-13 necessitates that the Company establish an allowance for expected credit losses for certain debt securities and other financial assets; however, allowances are not expected to be significant.
ASU 2017-04, Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment. This ASU simplifies the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in today’s two-step impairment test. Under the new guidance, if a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The standard eliminates today’s requirement to calculate a goodwill impairment charge using Step 2, which requires an entity to calculate any impairment charge by comparing the implied fair value of goodwill with its carrying amount. ASU 2017-04 became effective for the Company on January 1, 2020, and did not have a significant impact on its financial statements. The Company's policy is to test goodwill for impairment annually on December 31 or on an interim

8






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

basis if an event triggering impairment may have occurred. During the period ended March 31, 2020, the economic turmoil and market volatility resulting from the COVID-19 crisis resulted in a substantial decrease in the Company's stock price and market capitalization. Management believed such decrease was a triggering indicator requiring an interim goodwill impairment quantitative analysis. Under the new simplified guidance, the Company's estimated fair value to a market participant as of March 31, 2020, exceeded its carrying amount resulting in no impairment charge for the period. Management will continue to evaluate the economic conditions at future reporting periods for applicable changes.

ASU 2018-13, Fair Value Measurement (Topic 820) - Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements on fair value measurements by requiring that Level 3 fair value disclosures include the range and weighted average of significant unobservable inputs used to develop those fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 became effective for the Company on January 1, 2020 and did not have a significant impact on its financial statements and disclosures.

ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. This ASU became effective for the Company on January 1, 2020 and did not have a significant impact on its financial statements and disclosures.
Subsequent events: Companies are required to evaluate events and transactions that occur after the balance sheet date but before the date the financial statements are issued. They must recognize in the financial statements the effect of all events or transactions that provide additional evidence of conditions that existed at the balance sheet date, including the estimates inherent in the financial statement preparation process. Entities shall not recognize the impact of events or transactions that provide evidence about conditions that did not exist at the balance sheet date but arose after that date. The Company has evaluated subsequent events through the date of filing these financial statements with the Securities and Exchange Commission (SEC) and noted no subsequent events requiring financial statement recognition or disclosure, except as disclosed in Note 11.
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 and was authorized to continue through October 1, 2019. On October 17, 2019, the repurchase program was renewed and authorized to continue through December 31, 2020. As of December 31, 2019, the Company had repurchased a total of 897,738 shares of Company stock at a total cost of $49,048 under this program. There were no repurchases for the three months ended March 31, 2020 and 172,738 shares at a total cost of $10,000 purchased during the three months ended March 31, 2019. Shares of Company stock repurchased to settle employee tax withholding related to vesting of stock awards totaled 2,629 and 53,165 shares at a total cost of $145 and $2,507 for the three months ended March 31, 2020 and 2019, respectively, and were not included under this program.
Earnings per share: Basic earnings per common share is calculated as 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 nonforfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under participating nonvested restricted stock awards. The participating nonvested common stock was not included in dilutive shares as it was anti-dilutive for the three months ended March 31, 2019. Proceeds from the assumed exercise of dilutive participating nonvested restricted stock awards are assumed to be used to repurchase common stock at the average market price.

9






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 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 March 31,
   
2020
 
2019
Basic earnings per share:
   
 
   
Net income
$
44,167

 
$
37,131

Less:
 
 
 
Undistributed earnings allocated to participating securities
209

 
184

Dividends paid on participating securities
68

 
76

Net income available to common shareholders
$
43,890

 
$
36,871

Weighted average basic shares outstanding
42,741,399

 
43,453,424

Basic earnings per share
$
1.03

 
$
0.85

Diluted earnings per share:
   
 
   
Net income available to common shareholders
$
43,890

 
$
36,871

Total weighted average basic shares outstanding
42,741,399

 
43,453,424

Add dilutive participating securities
8,559

 

Total weighted average diluted shares outstanding
42,749,958

 
43,453,424

Diluted earnings per share
$
1.03

 
$
0.85

Anti-dilutive participating securities

 
52,866



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:   
 
 
Three Months Ended March 31,
 
 
2020
 
2019
Cash transactions:
 
 
 
 
Interest expense paid
 
$
35,400

 
$
32,673

Income taxes paid
 
$

 
$

Noncash transactions:
 
 
 
 
Transfers of loans to other real estate owned
 
$
3,914

 
$
544

Loans to facilitate the sale of other real estate owned
 
$
1,564

 
$

Securities sold, not yet settled
 
$

 
$
1,090

Right-of-use assets obtained in exchange for lease liabilities
 
$

 
$
33,878

Transfer of repurchase agreements to deposits
 
$

 
$
8,475

 
 
 
 
 

10






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:
 
 
Three Months Ended March 31,
 
 
2020
 
2019
Noncash assets acquired
 
 
 
 
Certificates of deposit held in other banks
 
$

 
$
262

Securities available for sale
 

 
561,052

Restricted stock
 

 
27,794

Loans
 

 
2,788,159

Premises and equipment
 

 
65,786

Other real estate owned
 

 
1,710

Goodwill
 

 
270,583

Other intangible assets
 

 
71,518

Bank owned life insurance
 

 
80,837

Other assets
 

 
31,517

Total assets acquired
 
$

 
$
3,899,218

Noncash liabilities assumed:
 
 
 
 
Deposits
 
$

 
$
3,108,810

Repurchase agreements
 

 
8,475

FHLB advances
 

 
142,653

Other borrowings
 

 
40,000

Junior subordinated debentures
 

 
25,774

Other liabilities
 

 
11,538

Total liabilities assumed
 
$

 
$
3,337,250

Cash and cash equivalents acquired from acquisitions
 
$

 
$
39,913

Cash paid to shareholders of acquired banks
 
$

 
$
9

Fair value of common stock issued to shareholders of acquired banks
 
$

 
$
601,872



11






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 March 31, 2020 and December 31, 2019 are as follows:
   
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Securities Available for Sale
 
   
 
   
 
   
 
   
March 31, 2020
 
   
 
   
 
   
 
   
U.S. treasuries
 
$
48,060

 
$
2,220

 
$

 
$
50,280

Government agency securities
 
175,694

 
3,491

 
(479
)
 
178,706

Obligations of state and municipal subdivisions
 
361,444

 
12,076

 
(406
)
 
373,114

Corporate bonds
 
5,001

 
157

 

 
5,158

Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
 
459,035

 
21,647

 
(4
)
 
480,678

Other securities
 
1,200

 

 

 
1,200

   
 
$
1,050,434

 
$
39,591

 
$
(889
)
 
$
1,089,136

December 31, 2019
 
   
 
   
 
   
 
   
U.S. treasuries
 
$
48,060

 
$
743

 
$
(7
)
 
$
48,796

Government agency securities
 
178,953

 
926

 
(583
)
 
179,296

Obligations of state and municipal subdivisions
 
332,715

 
11,150

 
(6
)
 
343,859

Corporate bonds
 
7,011

 
207

 

 
7,218

Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
 
493,915

 
11,981

 
(329
)
 
505,567

Other securities
 
1,200

 

 

 
1,200

   
 
$
1,061,854

 
$
25,007

 
$
(925
)
 
$
1,085,936


Securities with a carrying amount of approximately $708,666 and $571,843 at March 31, 2020 and December 31, 2019, respectively, were pledged primarily to secure deposits.
Proceeds from sale of securities available for sale and gross gains and gross losses for the three months ended March 31, 2020 and 2019 were as follows:
 
 
Three Months Ended March 31,
 
 
2020
 
2019
Proceeds from sale
 
$
13,100

 
$
185,508

Gross gains
 
$
359

 
$
273

Gross losses
 
$
3

 
$
28




12






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 March 31, 2020, by contractual maturity, are shown below. Maturities of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.   
 
 
March 31, 2020
 
 
Securities Available for Sale
 
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
37,151

 
$
37,580

Due from one year to five years
 
145,643

 
150,394

Due from five to ten years
 
172,008

 
176,848

Thereafter
 
236,597

 
243,636

 
 
591,399

 
608,458

Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
 
459,035

 
480,678

 
 
$
1,050,434

 
$
1,089,136


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 March 31, 2020 and December 31, 2019, 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
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
March 31, 2020
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
Government agency securities
 
2
 
14,505

 
(479
)
 
 

 

 
14,505

 
(479
)
Obligations of state and municipal subdivisions
 
7
 
25,306

 
(406
)
 
 

 

 
25,306

 
(406
)
Mortgage-backed securities guaranteed by FHLMC
 
 

 

 
1
 
1,095

 
(4
)
 
1,095

 
(4
)
   
 
9
 
$
39,811

 
$
(885
)
 
1
 
$
1,095

 
$
(4
)
 
$
40,906

 
$
(889
)
December 31, 2019
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
U.S. treasuries
 
 
$

 
$

 
2
 
$
8,097

 
$
(7
)
 
$
8,097

 
$
(7
)
Government agency securities
 
13
 
52,790

 
(495
)
 
6
 
15,911

 
(88
)
 
68,701

 
(583
)
Obligations of state and municipal subdivisions
 
5
 
2,793

 
(1
)
 
1
 
423

 
(5
)
 
3,216

 
(6
)
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
 
13
 
46,512

 
(317
)
 
1
 
1,193

 
(12
)
 
47,705

 
(329
)
   
 
31
 
$
102,095

 
$
(813
)
 
10
 
$
25,624

 
$
(112
)
 
$
127,719

 
$
(925
)

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.


13






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 March 31, 2020 and December 31, 2019, consisted of the following:
 
 
March 31,
 
December 31,
   
 
2020
 
2019
Commercial
 
$
2,611,183

 
$
2,482,356

Real estate:
 
   
 
   
Commercial
 
5,873,267

 
5,872,653

Commercial construction, land and land development
 
1,265,182

 
1,236,623

Residential
 
1,535,835

 
1,515,227

Single-family interim construction
 
381,125

 
378,120

Agricultural
 
97,491

 
97,767

Consumer
 
52,341

 
32,603

Other
 
1,105

 
621

   
 
11,817,529

 
11,615,970

Deferred loan fees
 
(854
)
 
(1,695
)
Allowance for loan losses
 
(58,403
)
 
(51,461
)
   
 
$
11,758,272

 
$
11,562,814



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 nonperforming 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 March 31, 2020 and December 31, 2019, there were approximately $181,545 and $189,781 of energy related loans outstanding, respectively. The Company has a mortgage warehouse purchase program providing mortgage inventory financing for residential mortgage loans originated by mortgage banker clients across a broad geographic scale. Proceeds from the sale of mortgages is the primary source of repayment for warehouse inventory financing via approved investor takeout commitments. These loans typically have a very short duration ranging between a few days to 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 March 31, 2020 and December 31, 2019, mortgage warehouse purchase loans outstanding totaled $796,609 and $687,317, respectively.

14






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 March 31, 2020, 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 March 31, 2020, loans in the Colorado region represented about 27% of the total portfolio. A large percentage of the Company’s portfolio consists of commercial and residential real estate loans. As of March 31, 2020 and December 31, 2019, 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.

15






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. External loan reviews cover a wide range of the loan portfolio, including large lending relationships and recently acquired loan portfolios. As such, the external loan review generally covers loans exceeding $3,500. 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 economy, specifically the Company’s lending area of north, central and southeast Texas area, and the Colorado economy had a sudden and broad-based weakening at the end of the first quarter of 2020. Many firms reported a sharp reduction in activity, resulting from business disruptions and closures due to the COVID-19 pandemic. Activity in the energy, retail, and service sectors was the hardest hit. Loan demand contracted broadly and credit quality eroded slightly, except in residential real estate lending, which increased during the period. Housing demand held up through mid-March but has declined notably since then. Outlooks worsened markedly and uncertainty surged, as the economic impact of the COVID-19 pandemic and related containment measures intensified. The duration of this pandemic crisis has been short but impactful and the timing and magnitude of recovery cannot be predicted. The risk of loss associated with all segments of the portfolio could increase due to these factors.


16






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 months ended March 31, 2020 and 2019:
 
Commercial
 
Commercial
Real Estate, Construction,
Land and Land
Development
 
Residential
Real Estate
 
Single-Family
Interim
Construction
 
Agricultural
 
Consumer
 
Other
 
Unallocated
 
Total
Three months ended March 31, 2020
 
 
 
 
 

 
 
 

 
 
 

 
 
Balance at beginning of period
$
12,844

 
$
33,085

 
$
3,678

 
$
1,606

 
$
332

 
$
226

 
$
5

 
$
(315
)
 
$
51,461

Provision for loan losses
5,053

 
1,733

 
759

 
307

 
13

 
28

 
131

 
357

 
8,381

Charge-offs
(571
)
 
(735
)
 

 
(82
)
 

 
(9
)
 
(112
)
 

 
(1,509
)
Recoveries
16

 

 

 

 

 
18

 
36

 

 
70

Balance at end of period
$
17,342

 
$
34,083

 
$
4,437

 
$
1,831

 
$
345

 
$
263

 
$
60

 
$
42

 
$
58,403

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
11,793

 
$
27,795

 
$
3,320

 
$
1,402

 
$
241

 
$
186

 
$
3

 
$
62

 
$
44,802

Provision for loan losses
1,913

 
910

 
267

 
62

 
43

 
(26
)
 
49

 
6

 
3,224

Charge-offs
(1,454
)
 

 
(93
)
 
(3
)
 

 
(8
)
 
(41
)
 

 
(1,599
)
Recoveries
43

 
3

 

 

 

 
15

 
17

 

 
78

Balance at end of period
$
12,295

 
$
28,708

 
$
3,494

 
$
1,461

 
$
284

 
$
167

 
$
28

 
$
68

 
$
46,505


17






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 March 31, 2020 and December 31, 2019:
 
Commercial
 
Commercial
Real Estate, Construction,
Land and Land
Development
 
Residential
Real Estate
 
Single-Family
Interim
Construction
 
Agricultural
 
Consumer
 
Other
 
Unallocated
 
Total
March 31, 2020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
3,862

 
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$
3,862

Collectively evaluated for impairment
12,906

 
34,083

 
4,437

 
1,831

 
345

 
263

 
60

 
42

 
53,967

Loans acquired with deteriorated credit quality
574

 

 

 

 

 

 

 

 
574

Ending balance
$
17,342

 
$
34,083

 
$
4,437

 
$
1,831

 
$
345

 
$
263

 
$
60

 
$
42

 
$
58,403

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
18,571

 
$
6,338

 
$
2,434

 
$

 
$

 
$
20

 
$

 
$

 
$
27,363

Collectively evaluated for impairment
2,536,762

 
6,925,445

 
1,526,282

 
381,125

 
94,636

 
52,303

 
1,105

 

 
11,517,658

Acquired with deteriorated credit quality
55,850

 
206,666

 
7,119

 

 
2,855

 
18

 

 

 
272,508

Ending balance
$
2,611,183

 
$
7,138,449

 
$
1,535,835

 
$
381,125

 
$
97,491

 
$
52,341

 
$
1,105

 
$

 
$
11,817,529

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
357

 
$

 
$

 
$

 
$

 
$
1

 
$

 
$

 
$
358

Collectively evaluated for impairment
12,108

 
32,615

 
3,678

 
1,606

 
332

 
225

 
5

 
(315
)
 
50,254

Loans acquired with deteriorated credit quality
379

 
470

 

 

 

 

 

 

 
849

Ending balance
$
12,844

 
$
33,085

 
$
3,678

 
$
1,606

 
$
332

 
$
226

 
$
5

 
$
(315
)
 
$
51,461

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
3,130

 
$
6,813

 
$
2,008

 
$

 
$
114

 
$
22

 
$

 
$

 
$
12,087

Collectively evaluated for impairment
2,416,569

 
6,883,639

 
1,505,896

 
378,120

 
93,837

 
32,556

 
621

 

 
11,311,238

Acquired with deteriorated credit quality
62,657

 
218,824

 
7,323

 

 
3,816

 
25

 

 

 
292,645

Ending balance
$
2,482,356

 
$
7,109,276

 
$
1,515,227

 
$
378,120

 
$
97,767

 
$
32,603

 
$
621

 
$

 
$
11,615,970












18






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 March 31, 2020 and December 31, 2019, are summarized as follows:   
 
 
Commercial
 
Commercial
Real Estate, Construction,
Land and Land
Development
 
Residential Real Estate
 
Single-Family
Interim
Construction
 
Agricultural
 
Consumer
 
Other
 
Total
March 31, 2020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonaccrual loans
 
$
18,571

 
$
4,483

 
$
2,249

 
$

 
$

 
$
20

 
$

 
$
25,323

Loans past due 90 days and still accruing
 
618

 

 
500

 

 

 
12

 

 
1,130

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

 
1,855

 
185

 

 

 

 

 
2,040

 
 
$
19,189

 
$
6,338

 
$
2,934

 
$

 
$

 
$
32

 
$

 
$
28,493

December 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonaccrual loans
 
$
3,130

 
$
6,461

 
$
1,820

 
$

 
$
114

 
$
22

 
$

 
$
11,547

Loans past due 90 days and still accruing
 
14,529

 

 

 

 

 

 

 
14,529

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

 
352

 
188

 

 

 

 

 
540

 
 
$
17,659

 
$
6,813

 
$
2,008

 
$

 
$
114

 
$
22

 
$

 
$
26,616


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 loan's 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 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.

19






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 March 31, 2020 and December 31, 2019, are summarized as follows:
 
 
Commercial
 
Commercial
Real Estate, Construction,
Land and Land
Development
 
Residential
Real Estate
 
Single-Family
Interim
Construction
 
Agricultural
 
Consumer
 
Other
 
Total
March 31, 2020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment in impaired loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans with an allowance for loan losses
 
$
17,765

 
$

 
$

 
$

 
$

 
$

 
$

 
$
17,765

Impaired loans with no allowance for loan losses
 
806

 
6,338

 
2,434

 

 

 
20

 

 
9,598

Total
 
$
18,571

 
$
6,338

 
$
2,434

 
$

 
$

 
$
20

 
$

 
$
27,363

Unpaid principal balance of impaired loans
 
$
25,927

 
$
6,835

 
$
2,664

 
$

 
$

 
$
22

 
$

 
$
35,448

Allowance for loan losses on impaired loans
 
$
3,862

 
$

 
$

 
$

 
$

 
$

 
$

 
$
3,862

December 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment in impaired loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans with an allowance for loan losses
 
$
1,580

 
$

 
$

 
$

 
$

 
$
1

 
$

 
$
1,581

Impaired loans with no allowance for loan losses
 
1,550

 
6,813

 
2,008

 

 
114

 
21

 

 
10,506

Total
 
$
3,130

 
$
6,813

 
$
2,008

 
$

 
$
114

 
$
22

 
$

 
$
12,087

Unpaid principal balance of impaired loans
 
$
8,580

 
$
6,967

 
$
2,197

 
$

 
$
123

 
$
24

 
$

 
$
17,891

Allowance for loan losses on impaired loans
 
$
357

 
$

 
$

 
$

 
$

 
$
1

 
$

 
$
358

For the three months ended March 31, 2020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
 
$
10,851

 
$
6,576

 
$
2,221

 
$

 
$
57

 
$
21

 
$

 
$
19,726

Interest income recognized on impaired loans
 
$
1

 
$
16

 
$
8

 
$

 
$

 
$

 
$

 
$
25

For the three months ended March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average recorded investment in impaired loans
 
$
7,619

 
$
1,532

 
$
1,644

 
$
1,789

 
$

 
$
28

 
$

 
$
12,612

Interest income recognized on impaired loans
 
$
18

 
$
22

 
$
4

 
$
109

 
$

 
$
5

 
$

 
$
158


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

20






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

A TDR 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 $2,686 and $1,208 as of March 31, 2020 and December 31, 2019, respectively.
Following is a summary of loans modified under troubled debt restructurings during the three months ended March 31, 2020:
 
 
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 March 31, 2020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of contracts
 

 
1

 

 

 

 

 

 
1

Pre-restructuring outstanding recorded investment
 
$

 
$
1,517

 
$

 
$

 
$

 
$

 
$

 
$
1,517

Post-restructuring outstanding recorded investment
 
$

 
$
1,517

 
$

 
$

 
$

 
$

 
$

 
$
1,517


There were no loans modified under troubled debt restructurings during the three months ended March 31, 2019.
At March 31, 2020 and 2019, there were no loans modified under troubled debt restructurings during the previous twelve month period that subsequently defaulted during the three months ended March 31, 2020 and 2019, respectively.
At March 31, 2020 and 2019, the Company had no commitments to lend additional funds to any borrowers with loans whose terms have been modified under troubled debt restructurings.

Under the CARES Act, banks may elect to deem that loan modifications do not result in TDRs if they are (1) related to COVID-19; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency or (B) December 31, 2020. At March 31, 2020, the Company has not made such an election. Additionally, other short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs under ASC Subtopic 310-40 and federal banking agencies interagency guidance. This includes short-term (e.g., up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. In response to the COVID-19 pandemic, the Company has implemented a short-term deferral modification program that complies with ASC Subtopic 310-40. As such, the Company's TDR loans noted above do not include loans that are short-term modifications to borrowers impacted by COVID-19.


21






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 March 31, 2020 and December 31, 2019:   
 
 
Loans
30-89 Days
Past Due
 
Loans
90 Days
or More
Past Due
 
Total Past
Due Loans
 
Current
Loans
 
Total
Loans
March 31, 2020
 
 
 
 
 
 
 
 
 
 
Commercial
 
$
21,808

 
$
18,765

 
$
40,573

 
$
2,514,760

 
$
2,555,333

Commercial real estate, construction, land and land development
 
12,224

 
3,876

 
16,100

 
6,915,683

 
6,931,783

Residential real estate
 
3,598

 
1,554

 
5,152

 
1,523,564

 
1,528,716

Single-family interim construction
 
468

 

 
468

 
380,657

 
381,125

Agricultural
 
829

 

 
829

 
93,807

 
94,636

Consumer
 
194

 
32

 
226

 
52,097

 
52,323

Other
 

 

 

 
1,105

 
1,105

 
 
39,121

 
24,227

 
63,348

 
11,481,673

 
11,545,021

Acquired with deteriorated credit quality
 
5,004

 
13,962

 
18,966

 
253,542

 
272,508

 
 
$
44,125

 
$
38,189

 
$
82,314

 
$
11,735,215

 
$
11,817,529

December 31, 2019
 
 
 
 
 
 
 
 
 
 
Commercial
 
$
4,512

 
$
17,656

 
$
22,168

 
$
2,397,531

 
$
2,419,699

Commercial real estate, construction, land and land development
 
9,153

 
2,905

 
12,058

 
6,878,394

 
6,890,452

Residential real estate
 
3,242

 
642

 
3,884

 
1,504,020

 
1,507,904

Single-family interim construction
 
2,836

 

 
2,836

 
375,284

 
378,120

Agricultural
 
22

 
114

 
136

 
93,815

 
93,951

Consumer
 
167

 
22

 
189

 
32,389

 
32,578

Other
 

 

 

 
621

 
621

 
 
19,932

 
21,339

 
41,271

 
11,282,054

 
11,323,325

Acquired with deteriorated credit quality
 
2,556

 
6,766

 
9,322

 
283,323

 
292,645

 
 
$
22,488

 
$
28,105

 
$
50,593

 
$
11,565,377

 
$
11,615,970


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.

22






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 March 31, 2020 and December 31, 2019, is as follows:   
 
 
Pass
 
Pass/
Watch
 
Special Mention
 
Substandard
 
Doubtful
 
Total
March 31, 2020
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
$
2,462,200

 
$
51,116

 
$
57,142

 
$
40,725

 
$

 
$
2,611,183

Commercial real estate, construction, land and land development
 
6,820,852

 
209,658

 
48,855

 
59,084

 

 
7,138,449

Residential real estate
 
1,520,123

 
5,970

 
1,054

 
8,688

 

 
1,535,835

Single-family interim construction
 
378,605

 
2,520

 

 

 

 
381,125

Agricultural
 
88,136

 
5,896

 
1,956

 
1,503

 

 
97,491

Consumer
 
52,175

 
35

 
2

 
129

 

 
52,341

Other
 
1,105

 

 

 

 

 
1,105

 
 
$
11,323,196

 
$
275,195

 
$
109,009

 
$
110,129

 
$

 
$
11,817,529

December 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
$
2,332,611

 
$
71,642

 
$
37,739

 
$
40,364

 
$

 
$
2,482,356

Commercial real estate, construction, land and land development
 
6,814,780

 
184,720

 
46,889

 
62,887

 

 
7,109,276

Residential real estate
 
1,501,019

 
4,850

 
994

 
8,364

 

 
1,515,227

Single-family interim construction
 
376,887

 
1,233

 

 

 

 
378,120

Agricultural
 
88,044

 
5,287

 
1,864

 
2,572

 

 
97,767

Consumer
 
32,459

 
33

 
2

 
109

 

 
32,603

Other
 
621

 

 

 

 

 
621

 
 
$
11,146,421

 
$
267,765

 
$
87,488

 
$
114,296

 
$

 
$
11,615,970


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 March 31, 2020 and December 31, 2019:
 
 
Pass
 
Pass/
Watch
 
Special Mention
 
Substandard
 
Doubtful
 
Total
March 31, 2020
 
$
208,852

 
$
30,782

 
$
3,781

 
$
29,093

 
$

 
$
272,508

December 31, 2019
 
232,095

 
21,284

 
4,502

 
34,764

 

 
292,645


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 March 31, 2020 and December 31, 2019, nonaccrual PCI loans were $17,023 and $10,850, respectively.

23






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:
 
 
Acquisition Date
 
 
January 1, 2019
   
 
Guaranty Bancorp
Outstanding balance
 
$
341,645

Nonaccretable difference
 
(16,622
)
Accretable yield
 
(13,299
)
Carrying amount
 
$
311,724


The carrying amount of all acquired PCI loans included in the consolidated balance sheet and the related outstanding balance at March 31, 2020 and December 31, 2019 were as follows:
 
March 31, 2020
 
December 31, 2019
Outstanding balance
$
303,744

 
$
326,077

Carrying amount
272,508

 
292,645


There was an allocation of $574 and $849 established in the allowance for loan losses relating to PCI loans at March 31, 2020 and December 31, 2019, respectively.
The changes in accretable yield during the three months ended March 31, 2020 and 2019 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 Three Months Ended March 31,
 
2020
 
2019
Balance at January 1,
$
8,905

 
$
1,436

Additions

 
14,704

Accretion
(834
)
 
(963
)
Transfers from nonaccretable

 

Balance at March 31,
$
8,071

 
$
15,177




24






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 5. Commitments and Contingencies
Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. The commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of this instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. At March 31, 2020 and December 31, 2019, the approximate amounts of these financial instruments were as follows:
   
 
March 31,
 
December 31,
 
 
2020
 
2019
Commitments to extend credit
 
$
2,224,411

 
$
2,337,385

Standby letters of credit
 
25,906

 
23,406

 
 
$
2,250,317

 
$
2,360,791


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 March 31, 2020 and December 31, 2019, no amounts have been recorded as liabilities for the Company’s potential obligations under these guarantees.
Change in Control Agreements
The Company has change-in-control agreements with each of its named executive officers. Under these agreements, each executive could receive, upon the effectiveness of a change-in-control and subsequent termination of employment, as defined in the agreement, a lump sum cash payment in an amount equal to two to three times (depending upon the executive) the sum, of the executive’s current annual base salary, plus the executive’s target annual bonus for the year of termination. In addition all of the executive’s unvested grants of restricted stock will immediately vest and the executive will continue to be a participant in the Independent Bank Survivor Benefit Plan.
 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.

25






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

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.

Note 6. Income Taxes
Income tax expense for the three months ended March 31, 2020 and 2019 was as follows:
 
Three Months Ended March 31,
 
2020
 
2019
Income tax expense for the period
$
10,836

 
$
11,126

Effective tax rate
19.7
%
 
23.1
%

The effective tax rates for 2020 and 2019 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 benefit on restricted stock vestings, nondeductible compensation, acquisition related expenses, and state income tax. In addition, the lower effective tax rate for the three months ended March 31, 2020 is a result of a tax benefit recorded due to the net operating loss carryback provision allowed through the enactment of the CARES Act.


26






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

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

The Company elected the fair value option for certain residential mortgage loans held for sale in accordance with 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 8, Derivative Financial Instruments, for additional information.

27






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 March 31, 2020 and December 31, 2019 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)
March 31, 2020
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Investment securities available for sale:
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
50,280

 
$

 
$
50,280

 
$

Government agency securities
 
178,706

 

 
178,706

 

Obligations of state and municipal subdivisions
 
373,114

 

 
373,114

 

Corporate bonds
 
5,158

 

 
5,158

 

Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
 
480,678

 

 
480,678

 

Other securities
 
1,200

 

 
1,200

 

Loans held for sale, fair value option elected (1)
 
32,736

 

 
32,736

 

Derivative financial instruments:
 
 
 
 
 
 
 
 
Interest rate lock commitments
 
1,417

 

 
1,417

 

Forward mortgage-backed securities trades
 
4

 

 
4

 

Loan customer counterparty
 
21,661

 

 
21,661

 

Liabilities:
 
 
 
 
 
 
 
 
Derivative financial instruments:
 
 
 
 
 
 
 
 
Interest rate lock commitments
 
19

 

 
19

 

Forward mortgage-backed securities trades
 
1,319

 

 
1,319

 

Financial institution counterparty
 
23,124

 

 
23,124

 

December 31, 2019
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Investment securities available for sale:
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
48,796

 
$

 
$
48,796

 
$

Government agency securities
 
179,296

 

 
179,296

 

Obligations of state and municipal subdivisions
 
343,859

 

 
343,859

 

Corporate bonds
 
7,218

 

 
7,218

 

Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
 
505,567

 

 
505,567

 

Other securities
 
1,200

 

 
1,200

 

Loans held for sale, fair value option elected (1)
 
29,204

 

 
29,204

 

Derivative financial instruments:
 
 
 
 
 
 
 
 
Interest rate lock commitments
 
847

 

 
847

 

Forward mortgage-backed securities trades
 
6

 

 
6

 

Loan customer counterparty
 
6,104

 

 
6,104

 

Liabilities:
 
 
 
 
 
 
 
 
Derivative financial instruments:
 
 
 
 
 
 
 
 
Forward mortgage-backed securities trades
 
69

 

 
69

 

Financial institution counterparty
 
6,566

 

 
6,566

 

____________
(1)
At March 31, 2020 and December 31, 2019, loans held for sale for which the fair value option was elected had an aggregate outstanding principal balance of $31,687 and $28,166, respectively. 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 March 31, 2020.

28






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

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 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 8, Derivative Financial Instruments, for more information.


29






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 March 31, 2020 and December 31, 2019, 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
March 31, 2020
 
   
 
   
 
   
 
   
 
   
Assets:
 
   
 
   
 
   
 
   
 
   
Impaired loans
 
$
14,021

 
$

 
$

 
$
14,021

 
$
3,699

 
 
 
 
 
 
 
 
 
 
 
December 31, 2019
 
 
 
   

 
   
 
   
 
   
Assets:
 
 
 
   
 
   
 
   
 
   
Impaired loans
 
$
2,276

 
$

 
$

 
$
2,276

 
$
1,806

Other real estate owned
 
4,618

 

 

 
4,618

 
749


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 March 31, 2020 and December 31, 2019, all mortgage loans held for sale not recorded under the fair value option were recorded at cost.


30






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 March 31, 2020 and December 31, 2019:
 
 
 
 
 
 
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)
March 31, 2020
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
948,907

 
$
948,907

 
$
948,907

 
$

 
$

Certificates of deposit held in other banks
 
5,719

 
5,963

 

 
5,963

 

Loans held for sale, at cost
 
6,691

 
6,824

 

 
6,824

 

Loans, net
 
11,758,272

 
11,632,914

 

 

 
11,632,914

FHLB of Dallas stock and other restricted stock
 
55,325

 
55,325

 

 
55,325

 

Accrued interest receivable
 
35,777

 
35,777

 

 
35,777

 

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits
 
11,882,766

 
11,897,145

 

 
11,897,145

 

Accrued interest payable
 
7,347

 
7,347

 

 
7,347

 

FHLB advances
 
975,000

 
952,713

 

 
952,713

 

Other borrowings
 
177,860

 
175,075

 

 
175,075

 

Junior subordinated debentures
 
53,874

 
39,559

 

 
39,559

 

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

 

 

 

 

Standby letters of credit
 

 

 

 

 

December 31, 2019
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
565,170

 
$
565,170

 
$
565,170

 
$

 
$

Certificates of deposit held in other banks
 
5,719

 
5,951

 

 
5,951

 

Loans held for sale, at cost
 
6,441

 
6,554

 

 
6,554

 

Loans, net
 
11,562,814

 
11,689,672

 

 

 
11,689,672

FHLB of Dallas stock and other restricted stock
 
30,052

 
30,052

 

 
30,052

 

Accrued interest receivable
 
35,860

 
35,860

 

 
35,860

 

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits
 
11,941,336

 
11,958,939

 

 
11,958,939

 

Accrued interest payable
 
9,583

 
9,583

 

 
9,583

 

FHLB advances
 
325,000

 
325,210

 

 
325,210

 

Other borrowings
 
202,251

 
209,050

 

 
209,050

 

Junior subordinated debentures
 
53,824

 
48,879

 

 
48,879

 

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

 

 

 

 

Standby letters of credit
 

 

 

 

 

 

31






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, 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.

32






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 8. 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.
The Company manages 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.
The following table provides the outstanding notional balances and fair values of outstanding derivative positions at March 31, 2020 and December 31, 2019:
   
 
Outstanding Notional Balance
 
Asset Derivative
Fair Value
 
Liability Derivative
Fair Value
March 31, 2020
 
   
 
   
 
   
Interest rate lock commitments
 
$
96,367

 
$
1,417

 
$
19

Forward mortgage-backed securities trades
 
70,000

 
4

 
1,319

Commercial loan interest rate swaps:
 


 


 


Loan customer counterparty
 
311,459

 
21,661

 

Financial institution counterparty
 
311,459

 

 
23,124

 
 
 
 
 
 
 
December 31, 2019
 
 
 
 
 
 
Interest rate lock commitments
 
$
28,434

 
$
847

 
$

Forward mortgage-backed securities trades
 
42,500

 
6

 
69

Commercial loan interest rate swaps:
 
 
 
 
 
 
Loan customer counterparty
 
280,751

 
6,104

 

Financial institution counterparty
 
280,751

 

 
6,566



33






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

The commercial loan customer counterparty weighted average received and paid interest rates for interest rate swaps outstanding were as follows:
 
 
Weighted Average Interest Rate
 
 
March 31, 2020
 
December 31, 2019
   
 
Received
 
Paid
 
Received
 
Paid
Loan customer counterparty
 
4.17
%
 
2.91
%
 
4.23
%
 
3.77
%

The credit exposure related to interest rate swaps is limited to the net favorable value of all swaps by each counterparty, which was approximately $21,661 at March 31, 2020. In some cases collateral may be required from the counterparties involved if the net value of the derivative instruments exceeds a nominal amount. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. At March 31, 2020, cash of $20,487 and securities of $6,726 were pledged as collateral for these derivatives.
During 2019, the Company entered into a credit risk participation agreement with a financial institution counterparty for interest rate swaps related to loans in which the Company is the lead bank. This agreement provides credit protection to the Company should the borrower fail to perform on its interest rate derivative contract. The agreement has a notional amount of $9,789 at March 31, 2020.
The 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 (loss) for the three months ended March 31, 2020 and 2019 was as follows:
 
 
Three Months Ended March 31,
 
 
2020
 
2019
Derivatives not designated as hedging instruments
 
 
 
 
Interest rate lock commitments
 
$
551

 
$
430

Forward mortgage-backed securities trades
 
(1,252
)
 
9



Note 9. Stock Awards
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. The Plan, as amended, has 2,300,000 reserved shares of common stock to be awarded by the Company’s compensation committee. As of March 31, 2020, there were 1,357,947 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. As defined in the plan, outstanding awards may immediately vest upon a change-in-control in the Company. Shares granted under the 2013 Equity Incentive Plan were issued at the date of grant and receive dividends.

34






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

In connection with the January 1, 2019 acquisition of Guaranty Bancorp (Guaranty), 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 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 three months ended March 31, 2020 and 2019:
   
 
Number of
Shares
 
Weighted Average
Grant Date
Fair Value
Nonvested shares, December 31, 2019
 
284,861

 
$
58.63

Granted during the period
 
94,177

 
53.48

Vested during the period
 
(78,599
)
 
57.94

Nonvested shares, March 31, 2020
 
300,439

 
$
57.19

 
 
 
 
 
Nonvested shares, December 31, 2018
 
252,903

 
$
62.81

Acquired awards replaced during the period
 
70,248

 
45.77

Granted during the period
 
111,751

 
50.78

Vested during the period
 
(84,388
)
 
37.32

Forfeited during the period
 
(385
)
 
45.77

Nonvested shares, March 31, 2019
 
350,129

 
$
52.58


Compensation expense related to these awards is recorded based on the fair value of the award at the date of grant and totaled $1,882 and $2,172 for the three months ended March 31, 2020 and 2019, respectively. Compensation expense is recorded in salaries and employee benefits in the accompanying consolidated statements of income. At March 31, 2020, future compensation expense is estimated to be $14,418 and will be recognized over a remaining weighted average period of 2.45 years.
The fair value of common stock awards that vested during the three months ended March 31, 2020 and 2019 was $4,198 and $4,542, respectively. The Company recorded $80 and $(20) in excess tax expense (benefit) on vested restricted stock to income tax expense for the three months ended March 31, 2020 and 2019, respectively.
There were no modifications of stock agreements during the three months ended March 31, 2020 and 2019 that resulted in significant additional incremental compensation costs.
At March 31, 2020, the future vesting schedule of the nonvested shares is as follows:
First year
 
136,940

Second year
 
96,445

Third year
 
59,234

Fourth year
 
7,540

Fifth year
 
280

Total nonvested shares
 
300,439




35






Independent Bank Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 10. 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.
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 March 31, 2020 and December 31, 2019, the Company and the Bank meet all capital adequacy requirements to which they are subject, including the capital buffer requirement.
As of March 31, 2020 and December 31, 2019, 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.

36






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 actual capital amounts and required ratios under Basel III Capital Rules for the Company and Bank as of March 31, 2020 and December 31, 2019.
 
   
 
Actual
 
Minimum for Capital
Required - Basel III
Fully Phased-In
 
To be Well Capitalized Under Prompt Corrective Action Provisions
   
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
March 31, 2020
 
   
 
   
 
   
 
   
 
   
 
   
Total capital to risk weighted assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
$
1,557,552

 
12.05
%
 
$
1,357,206

 
10.50
%
 
 N/A

 
 N/A

Bank
 
1,565,975

 
12.12

 
1,356,699

 
10.50

 
$
1,292,094

 
10.00
%
Tier 1 capital to risk weighted assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
1,341,149

 
10.38

 
1,098,690

 
8.50

 
 N/A

 
 N/A

Bank
 
1,507,572

 
11.67

 
1,098,280

 
8.50

 
1,033,675

 
8.00

Common equity tier 1 to risk weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
1,285,549

 
9.95

 
904,804

 
7.00

 
 N/A

 
 N/A

Bank
 
1,507,572

 
11.67

 
904,466

 
7.00

 
839,861

 
6.50

Tier 1 capital to average assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
1,341,149

 
9.67

 
554,640

 
4.00

 
 N/A

 
 N/A

Bank
 
1,507,572

 
10.88

 
554,445

 
4.00

 
693,056

 
5.00

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2019
 
   
 
   
 
   
 
   
 
   
 
   
Total capital to risk weighted assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
$
1,513,209

 
11.83
%
 
$
1,343,114

 
10.50
%
 
N/A

 
N/A

Bank
 
1,548,103

 
12.11

 
1,342,595

 
10.50

 
$
1,278,662

 
10.00
%
Tier 1 capital to risk weighted assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
1,303,748

 
10.19

 
1,087,282

 
8.50

 
N/A

 
N/A

Bank
 
1,496,642

 
11.70

 
1,086,863

 
8.50

 
1,022,930

 
8.00

Common equity tier 1 to risk weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
1,248,148

 
9.76

 
895,409

 
7.00

 
N/A

 
N/A

Bank
 
1,496,642

 
11.70

 
895,064

 
7.00

 
831,130

 
6.50

Tier 1 capital to average assets:
 
   
 
   
 
   
 
   
 
   
 
   
Consolidated
 
1,303,748

 
9.32

 
559,758

 
4.00

 
N/A

 
N/A

Bank
 
1,496,642

 
10.70

 
559,584

 
4.00

 
699,480

 
5.00



Note 11. Subsequent Events
Declaration of Dividends
On April 29, 2020, the Company declared a quarterly cash dividend in the amount of $0.25 per share of common stock to the stockholders of record on May 11, 2020. The dividend will be paid on May 21, 2020.


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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, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and other related federal security 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:
the disruption to local, regional, national and global economic activity caused by infectious disease outbreaks, including the recent outbreak of coronavirus, or COVID-19, and the significant impact that such outbreak has had and may have on our growth, operations, earnings and asset quality;
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 on loans and higher levels of nonperforming loans and loan charge-offs generally, and specifically resulting from the economic dislocation caused by the COVID-19 pandemic;
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 generally, and specifically as a result of the effect of the COVID-19 pandemic;
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;

38






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 that affect the net interest income, other future cash flows, or the market value of the assets of each of Independent Bank and the financial institutions that we acquire, including investment securities;
fluctuations in the market value and liquidity of the securities we hold for sale, including as a result of changes in market interest rates;
effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
changes in economic and market conditions, including the economic dislocation resulting from the COVID-19 pandemic, 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, including the economic dislocation resulting from the COVID-19 pandemic;
the impact of recent and future legislative regulatory changes, including changes in banking, securities, and tax laws and regulations and their application by the Company’s regulators, and changes in federal government policies, as well as regulatory requirements applicable to, and resulting from regulatory supervision of, the Company and Independent Bank as a financial institution with total assets greater than $10 billion;
changes in accounting policies, practices, principles and guidelines, 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 natural disasters such as 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, including but not limited to those identified below for the merger between the Company and Texas Capital Bancshares, Inc. (“TCBI”);
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 generally, and specifically as a result of the COVID-19 pandemic;
changes occur in business conditions and inflation generally, and specifically as a result of the COVID-19 pandemic;
an increase in the rate of personal or commercial customers’ bankruptcies generally, and specifically as a result of the COVID-19 pandemic;
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 we 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;

39






the potential impact of technology and “FinTech” entities on the banking industry generally;
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.” and
other economic, competitive, governmental, regulatory, technological and geopolitical factors affecting the Company’s operations, pricing and services.
In addition to the general factors listed above, additional factors specifically pertaining to the ongoing merger between the Company and TCBI that could also cause the results of performance to differ materially from those expressed in forward looking statements include the following:
the occurrence of any event, change or other circumstances that could give rise to the right of one or both of the parties to terminate the merger agreement;
the outcome of pending or threatened litigation, or of matters before regulatory agencies, whether currently existing or commencing in the future, including litigation related to the merger;
delays in completing the transaction;
the failure to obtain necessary regulatory approvals (and the risk that such approvals may result in the imposition of conditions that could adversely affect the combined company or the expected benefits of the transaction) and shareholder approvals or to satisfy any of the other conditions to the closing of the merger on a timely basis or at all;
the possibility that the anticipated benefits of the transaction are not realized when expected or at all, including as a result of the impact of, or problems arising from, the integration of the two companies or as a result of the strength of the economy and competitive factors in the areas where the Company and TCBI do business;
the possibility that the transaction may be more expensive to complete than anticipated, including as a result of unexpected factors or events;
the impact of purchase accounting with respect to the merger, or any change in assumptions used regarding the assets purchased and liabilities assumed to determine their fair value;
diversion of management’s attention from ongoing business operations and opportunities;
potential adverse reactions or changes to business or employee relationships, including those resulting from the announcement or completion of the transition;
the ability to complete the transaction and integration of the Company and TCBI successfully, which may take longer than anticipated or be more costly than anticipated or have unanticipated adverse results relating to the Company or TCBI’s existing businesses;
the challenges of integrating, retaining, and hiring key personnel;
failure to attract new customers and retain existing customers in the manner anticipated;
any interruption or breach of security as a result of systems integration, resulting in failures or disruption in customer account management, general ledger, deposit, loan or other systems;
changes in the Company’s stock price before closing, including as a result of the financial performance of TCBI prior to closing;
the dilution caused by the Company’s issuance of additional shares of its capital stock in connections with the transaction;
operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which the Company and TCBI are highly dependent; and
changes in the Company’s credit ratings or in the Company's ability to access the capital markets.
We urge you to consider all of these risks, uncertainties and other factors carefully in evaluating all such forward-looking statements that we may make. As a result of these and other matters, including changes in facts and assumptions not being realized, the actual results relating to the subject matter of any forward-looking statement may differ materially from the anticipated results expressed or implied in that forward-looking statement. Any forward-looking statement made by the Company in any report, filing, press release, document, report or announcement speaks only as of the date on which it is made. The Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.
A forward looking-statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company 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.

40






Additional Information about the Merger and Where to Find It
In connection with the proposed merger between the Company and TCBI, the Company filed a registration statement on Form S-4 with the SEC on January 21, 2020, as amended on March 6, 2020, to register the shares of the Company’s capital stock to be issued in connection with the merger. The registration statement includes a joint proxy statement/prospectus. The registration statement has not yet become effective. After the Form S-4 is effective, a definitive joint proxy statement/prospectus will be sent to the shareholders of the Company and TCBI seeking their approval of the proposed transaction.
INVESTORS AND SECURITY HOLDERS ARE URGED TO READ THE REGISTRATION STATEMENT ON FORM S-4, THE JOINT PROXY STATEMENT/PROSPECTUS INCLUDED WITHIN THE REGISTRATION STATEMENT ON FORM S-4 AND ANY OTHER RELEVANT DOCUMENTS FILED OR TO BE FILED WITH THE SEC IN CONNECTION WITH THE PROPOSED TRANSACTION BECAUSE THESE DOCUMENTS DO AND WILL CONTAIN IMPORTANT INFORMATION ABOUT THE COMPANY, TCBI AND THE PROPOSED TRANSACTION.
Investors and security holders may obtain copies of these documents free of charge through the website maintained by the SEC at www.sec.gov or from the Company at its website, www.ibtx.com, or from TCBI at its website, www.texascapitalbank.com. Documents filed with the SEC by the Company will be available free of charge by accessing the Investor Relations page of the Company’s website at www.ibtx.com or, alternatively, by directing a request by telephone or mail to Independent Bank Group, Inc., 7777 Henneman Way, McKinney, Texas 75070, (972) 562-9004, and documents filed with the SEC by TCBI will be available free of charge by accessing TCBI’s website at www.texascapitalbank.com under the tab “About Us,” and then under the heading “Investor Relations” or, alternatively, by directing a request by telephone or mail to Texas Capital Bancshares, Inc., 2000 McKinney Avenue, Suite 700, Dallas, Texas 75201, (214) 932-6600.

Participants in the Solicitation
The Company, TCBI and certain of their respective directors and executive officers may be deemed to be participants in the solicitation of proxies from the shareholders of the Company and TCBI in connection with the proposed transaction under the rules of the SEC. Certain information regarding the interests of these participants and a description of their direct and indirect interests, by security holdings or otherwise, will be included in the joint proxy statement/prospectus regarding the proposed transaction when it becomes available. Additional information about the Company, and its directors and executive officers, may be found in the Company’s Annual Report on Form 10-K filed with the SEC on March 2, 2020, as amended by the Company’s Annual Report on Form 10-K/A filed with the SEC on March 6, 2020, and other documents filed by the Company with the SEC. Additional information about TCBI, and its directors and executive officers, may be found in TCBI’s Annual Report on Form 10-K filed with the SEC on February 12, 2020, as amended by TCBI’s Annual Report on Form 10-K/A filed with the SEC on March 2, 2020, and other documents filed by TCBI with the SEC. These documents can be obtained free of charge from the sources described above.


41






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, as amended, for the year ended December 31, 2019.
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 the Company’s market areas or in new 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 March 31, 2020, the Company operated 93 full service banking locations in north, central and southeast Texas regions, and along the Colorado Front Range region, with 60 Texas locations and 33 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.
The Company’s principal business is lending to and accepting deposits from businesses, professionals and individuals. The Company conducts all of the Company’s banking operations through Independent Bank, which is a Texas state banking corporation and the Company's principal subsidiary (the Bank). The Company derives its income principally from interest earned on loans and, to a lesser extent, income from securities available for sale. The Company also derives 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, the Company also realizes gains on the sale of assets. The Company’s 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, communication and technology costs, expenses associated with other real estate owned, other administrative expenses, amortization of intangibles, acquisition expenses, provisions for loan losses and the Company’s assessment for FDIC deposit insurance.
Recent Developments: COVID-19
In March 2020, the outbreak of the Coronavirus Disease 2019 (COVID-19) was recognized as a pandemic by the World Health Organization. The spread of COVID-19 has caused economic and social disruption resulting in unprecedented uncertainty, volatility and disruption in financial markets, and has placed significant health, economic and other major pressures throughout the communities we serve, the United States and globally. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption has resulted in the shuttering of businesses across the country, significant job loss, material decreases in oil and gas prices and in business valuations, changes in consumer behavior related to pandemic fears, and aggressive measures by the federal government.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The CARES Act also includes a range of other provisions designed to support the U.S. economy and mitigate the impact of COVID-19 on financial institutions and their customers, including through the authorization of various programs and measures that the U.S. Department of the Treasury, the Small Business Administration, the Federal Reserve Board, and other federal banking agencies may or are required to implement. Further, in response to the COVID-19 outbreak, the Federal Reserve Board has implemented or announced a number of facilities to provide emergency liquidity to various segments of the U.S. economy and financial market.


42






Under the CARES Act, financial institutions are permitted to delay the implementation of ASU 2016-13, Financial Instruments - Credit Losses (CECL) until the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. The Company has elected such provision and will defer the adoption of CECL until such time has occurred with an effective retrospective implementation date of January 1, 2020. Refer to Note 1, Summary of Significant Accounting Policies, to the Company's consolidated financial statements included elsewhere in this report. Additionally, in a related action to the CARES Act, the joint federal bank regulatory agencies issued an interim final rule effective March 31, 2020, that allows banking organizations that implement CECL this year to elect to mitigate the effects of the CECL accounting standard on their regulatory capital for two years. This two-year delay is in addition to the three-year transition period that the agencies had already made available. Upon such point of adoption of CECL during 2020, the Company will elect to defer the regulatory capital effects of CECL in accordance with the interim final rule.

The CARES Act also includes a provision that permits a financial institution to elect to suspend temporarily troubled debt restructuring accounting under ASC Subtopic 310-40 in certain circumstances (“section 4013”). To be eligible under section 4013, a loan modification must be (1) related to COVID-19; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency or (B) December 31, 2020. In response to this section of the CARES Act, the federal banking agencies issued a revised interagency statement on April 7, 2020 that, in consultation with the Financial Accounting Standards Board, confirmed that for loans not subject to section 4013, short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not troubled debt restructurings under ASC Subtopic 310-40. This includes short-term (e.g., up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. As of March 31, 2020, the Company has not made the election under the CARES Act.
In response to the pandemic, the Company has implemented a number of procedures to support the safety and well-being of its employees, customers and shareholders. In addition, the Company has taken deliberate actions to ensure the continued health and strength of its balance sheet in order to serve its clients and communities.
Employees, Customers and Communities

The Company is supporting the health and safety of its employees and customers, and complying with government directives, through responsible operations administered under its board approved business continuity plan and protocols:
All branches currently operate on a “drive-thru only” or “lobby appointment only” model.
The company has implemented an employee work-from-home plan where possible.
Extra precautions are being taken to safeguard health and safety in branch facilities.
The Company is participating in the CARES Act Paycheck Protection Program (PPP) by originating these Small Business Administration (SBA) loans for its customers. As of April 27, 2020, the Company has received SBA authorization for over 4,600 PPP loans totaling over $730 million in aggregate for existing customers. Refer to the section captioned "Liquidity Management" elsewhere in this discussion for additional information.
The Company has implemented a short-term deferral modification program that complies with federal banking regulator's interagency guidance and is working with borrowers effected by COVID-19 on a case by case basis. Refer to Note 4, Loans, Net and Allowance for Loan Losses, to the Company's consolidated financial statements included elsewhere in this report.
The Company has made donations totaling $100,000 to support food banks across its footprint, which will provide 355,000 meals to those most vulnerable during the crisis.

Capital, Liquidity & Credit

Capital remains strong, with ratios of the Company, and its subsidiary bank, well above the standards to be considered well-capitalized under regulatory requirements.
Liquidity remains strong, with cash and securities representing approximately 13.1% of assets as of March 31, 2020. The Company maintains the ability to access considerable sources of contingent liquidity at the Federal Home Loan Bank and the Federal Reserve. Management considers the Company's current liquidity position to be adequate to meet short-term and long-term liquidity needs.
Asset quality remains solid, reflecting a long history of resilient credit quality and disciplined underwriting that the Company has built over three decades.

43






The Company's COVID-19 industry exposures are in the following loan categories as of March 31, 2020:
Commercial real estate (CRE) loans were $5.9 billion. The average loan size in the CRE portfolio is $1.0 million and the average loan-to-value for loans in the CRE portfolio is 49.8%.
Construction and Development (C&D) loans were $1.6 billion. The average loan size in the C&D portfolio was $645.9 thousand and the average loan-to-value was 58.4%. As of April 27, 2020, construction activity remains active as an essential industry across Texas and Colorado, and 98.5% of the Company’s C&D loans are located in either Texas or Colorado. Of the Company’s C&D loans, 40.5% are for owner-occupied properties.
The Company has approximately $432.3 million of loans secured by hotel and motel properties, with 91.3% of these loans located in either Texas or Colorado. The average loan size of loans secured by hotel and motel properties is $5.0 million, of which 78.9% are secured by limited/select service franchise properties, 17.0% are secured by full-service franchise properties, and 4.1% are secured by boutique/independent properties.
Energy loans were $181.5 million, or 1.6% of total loans held for investment, excluding mortgage warehouse purchase loans. Energy loans are secured 86.7% by exploration and production of oil and gas, and 13.3% by energy services companies.

The duration of this pandemic crisis has been short but impactful and the timing and magnitude of recovery cannot be predicted. The Company continues to closely monitor the impact of COVID -19 on its customers and the communities it serves; however, the extent to which the pandemic will impact operations and financial results during the remainder of 2020 is uncertain.
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 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.
During 2019, the Company completed a rebalancing of 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 2019 and one Colorado reduction as well as a branch sale during third quarter of 2019. In addition, during fourth quarter of 2019, the Company sold the trust business acquired in the Guaranty acquisition.
The comparability of the Company's results of operations for the three months ended March 31, 2020 and 2019 are affected by these transactions.
Pending Acquisition
Proposed merger with Texas Capital Bancshares, Inc. The Company and Texas Capital Bancshares, Inc. (TCBI) have entered into an Agreement and Plan of Merger, dated as of December 9, 2019, which is referred to as the "merger agreement." Under the merger agreement, the Company and TCBI have agreed to combine their respective companies in an all stock-merger of equals, pursuant to which TCBI will merge with and into the Company, with the Company continuing as the surviving entity, in a transaction which is referred to as "the merger." Immediately following the merger, Texas Capital Bank will merge with and into Independent Bank, with Independent Bank as the surviving bank. As of December 31, 2019, TCBI, on a consolidated basis, reported total assets of $32.5 billion, total deposits of $26.5 billion, and total equity capital of $2.8 billion.
The name of the surviving entity will be Independent Bank Group, Inc. and the name of the surviving bank will be Texas Capital Bank. The surviving bank will be operated under the name Independent Financial in Colorado and under the name Texas Capital Bank in Texas. After the merger, the 11 banking centers of Texas Capital Bank will become banking centers of the surviving bank. The surviving entity will trade under the Independent Bank Group ticker symbol "IBTX" on the Nasdaq Global Select Market.

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The merger agreement was unanimously approved by each company's board of directors. The transaction is anticipated to close in mid-2020, subject to customary closing conditions, including receipt of shareholder and regulatory approvals. The transaction is discussed in more detail in Note 1, Summary of Significant Accounting Policies, to the Company's consolidated financial statements included elsewhere in this report.

Discussion and Analysis of Results of Operations for the Three Months Ended March 31, 2020 and 2019
The following discussion and analysis of the Company's results of operations compares the operations for the three months ended March 31, 2020 with the three months ended March 31, 2019. The results of operations for the three months ended March 31, 2020 are not necessarily indicative of the results of operations that may be expected for all of the year ending December 31, 2020.
Results of Operations
For the three months ended March 31, 2020, net income was $44.2 million ($1.03 per common share on a diluted basis) compared with net income of $37.1 million ($0.85 per common share on a diluted basis) for the three months ended March 31, 2019. The Company posted annualized returns on average equity of 7.50% and 6.78%, returns on average assets of 1.19% and 1.08% and efficiency ratios of 51.68% and 60.37% for the three months ended March 31, 2020 and 2019, 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.
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 $123.2 million for the three months ended March 31, 2020, an increase of $1.6 million, or 1.3%, from $121.7 million for the three months ended March 31, 2019. This increase is due primarily to a $972.8 million increase, or 8.0%, in average interest earning assets to $13.2 billion for the three months ended March 31, 2020 compared to $12.2 billion for the three months ended March 31, 2019. The increase is primarily due to organic growth. The yield on average interest earning assets decreased 39 basis points from 5.17% for the three months ended March 31, 2019 to 4.78% for the three months ended March 31, 2020. The decrease from the prior year was due primarily to lower rates on interest-earning assets due to decreases in the Fed Funds rate during the last half of 2019. The average cost of interest-bearing liabilities decreased 17 basis points to 1.42% for the three months ended March 31, 2020 compared to 1.59% for the three months ended March 31, 2019. The decrease is primarily due to lower rates offered on our deposits, primarily promotional certificate of deposit products and money market accounts, tied to Fed Funds rates, as well as rate decreases on short-term FHLB advances and our other debt. The aforementioned changes resulted in a 29 basis point decrease in the net interest margin for the three months ended March 31, 2020 at 3.76% compared to 4.05% for the three months ended March 31, 2019. The decrease is primarily due to the three decreases in the Fed funds rate during the last half of 2019.


45






Average Balance Sheet Amounts, Interest Earned and Yield Analysis.  The following table present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three months ended March 31, 2020 and 2019. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances.
   
 
Three Months Ended March 31,
   
 
2020
 
2019
(dollars in thousands)
 
Average
Outstanding
Balance
 
Interest
 
Yield/
Rate
(4)
 
Average
Outstanding
Balance
 
Interest
 
Yield/
Rate
(4)
Interest-earning assets:
 
   
 
   
 
   
 
   
 
   
 
   
Loans (1)
 
$
11,537,343

 
$
147,105

 
5.13
%
 
$
10,708,761

 
$
145,531

 
5.51
%
Taxable securities
 
764,836

 
5,164

 
2.72

 
772,782

 
5,450

 
2.86

Nontaxable securities
 
329,642

 
2,065

 
2.52

 
334,976

 
2,225

 
2.69

Interest-bearing deposits and other
 
537,575

 
2,071

 
1.55

 
380,062

 
2,370

 
2.53

Total interest-earning assets
 
13,169,396

 
156,405

 
4.78

 
12,196,581

 
155,576

 
5.17

Noninterest-earning assets
 
1,796,232

 
   
 
   
 
1,778,611

 
   
 
   
Total assets
 
$
14,965,628

 
   
 
   
 
$
13,975,192

 
   
 
   
Interest-bearing liabilities:
 
   
 
   
 
   
 
   
 
   
 
   
Checking accounts
 
$
4,331,589

 
$
10,973

 
1.02
%
 
$
3,909,144

 
$
10,097

 
1.05
%
Savings accounts
 
550,418

 
265

 
0.19

 
504,880

 
325

 
0.26

Money market accounts
 
2,050,024

 
7,813

 
1.53

 
1,899,263

 
9,611

 
2.05

Certificates of deposit
 
1,817,209

 
9,020

 
2.00

 
1,657,869

 
7,809

 
1.91

Total deposits
 
8,749,240

 
28,071

 
1.29

 
7,971,156

 
27,842

 
1.42

FHLB advances
 
410,165

 
1,626

 
1.59

 
446,029

 
2,610

 
2.37

Other borrowings and repurchase agreements
 
194,844

 
2,795

 
5.77

 
185,684

 
2,715

 
5.93

Junior subordinated debentures
 
53,856

 
672

 
5.02

 
53,659

 
757

 
5.72

Total interest-bearing liabilities
 
9,408,105

 
33,164

 
1.42

 
8,656,528

 
33,924

 
1.59

Noninterest-bearing checking accounts
 
3,097,184

 
   
 
   
 
3,024,361

 
   
 
   
Noninterest-bearing liabilities
 
91,114

 
   
 
   
 
74,770

 
   
 
   
Stockholders’ equity
 
2,369,225

 
   
 
   
 
2,219,533

 
   
 
   
Total liabilities and equity
 
$
14,965,628

 
   
 
   
 
$
13,975,192

 
   
 
   
Net interest income
 
   
 
$
123,241

 
   
 
   
 
$
121,652

 
   
Interest rate spread
 
   
 
   
 
3.36
%
 
   
 
   
 
3.58
%
Net interest margin (2)
 
   
 
   
 
3.76

 
   
 
   
 
4.05

Net interest income and margin (tax equivalent basis) (3)
 
 
 
$
124,154

 
3.79

 
 
 
$
122,565

 
4.08

Average interest-earning assets to interest-bearing liabilities
 
   
 
   
 
139.98

 
   
 
   
 
140.89

 
 
 
 
 
 
 
 
 
 
 
 
 
_____________________
(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 months ended March 31, 2020 and 2019.
(4) Yield and rates for the three month periods are annualized.


46






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 $8.4 million provision for loan losses for the three months ended March 31, 2020 compared to $3.2 million for the comparable period in 2019. Provision expense is generally reflective of organic loan growth as well as charge-offs or specific reserves taken during the respective period. The increase from prior year is primarily due to general provision expense incurred in first quarter 2020 due to economic factors related to the COVID-19 crisis. The increase is also reflective of a specific reserve allocation of $2.8 million placed on an energy credit during the three months ended March 31, 2020 as well as $1.3 million in charge-offs related to a commercial real estate credit and an energy credit. Net charge-offs were $1.4 million and $1.5 million for the three months ended March 31, 2020 and 2019, respectively. Net charge-offs for the three months ended March 31, 2020 were primarily due to the $1.3 million in charge-offs noted above while net charge-offs for the three months ended March 31, 2019 were elevated due to $402 thousand in nonaccrual charge-offs and a partial charge-off totaling $827 thousand related to an energy loan.
Noninterest Income
The following table sets forth the components of noninterest income for the three months ended March 31, 2020 and 2019 and the period-over-period variations in such categories of noninterest income:
 
Three Months Ended March 31,
 
Variance
(dollars in thousands)
2020
 
2019
 
2020 v. 2019
Noninterest Income
 
 
 
 
 
 
 
Service charges on deposit accounts
$
5,542

 
$
5,910

 
$
(368
)
 
(6.2
)%
Investment management and trust
1,986

 
2,219

 
(233
)
 
(10.5
)%
Mortgage banking revenue
2,525

 
3,093

 
(568
)
 
(18.4
)
Loss on sale of loans
(42
)
 

 
(42
)
 
N/M

Gain on sale of other real estate
25

 

 
25

 
N/M

Gain on sale of securities available for sale
356

 
245

 
111

 
N/M

(Loss) gain on sale and disposal of premises and equipment
(63
)
 
9

 
(72
)
 
N/M

Increase in cash surrender value of BOLI
1,341

 
1,359

 
(18
)
 
(1.3
)
Other
2,841

 
3,589

 
(748
)
 
(20.8
)
Total noninterest income
$
14,511

 
$
16,424

 
$
(1,913
)
 
(11.6
)%
____________
N/M - not meaningful
Total noninterest income decreased $1.9 million, or 11.6% for the three months ended March 31, 2020 over same period in 2019. Significant changes in the components of noninterest income are discussed below.
Mortgage banking revenue. Mortgage banking revenue decreased $568 thousand, or 18.4% for the three months ended March 31, 2020 as compared to the same period in 2019. The decrease was primarily reflective of current market volatility, which resulted in fair value losses on our derivative hedging instruments of $1.6 million for the three months ended March 31, 2020, compared to $369 thousand for the same period in 2019.



47






Other. Other noninterest income decreased $748 thousand, or 20.8% for the three months ended March 31, 2020 as compared to the same period in 2019. The decrease from the prior year period is due to decreases in acquired loan recoveries and swap dealer income offset by higher mortgage warehouse fees and miscellaneous income.
Noninterest Expense
Noninterest expense decreased $12.2 million, or 14.1% for the three months ended March 31, 2020 as compared to the same period in 2019. The following table sets forth the components of the Company’s noninterest expense for the three months ended March 31, 2020 and 2019 and the period-over-period variations in such categories of noninterest expense:

Three Months Ended March 31,
 
Variance
(dollars in thousands)
2020
 
2019
 
2020 v. 2019
Noninterest Expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
38,660

 
$
42,380

 
$
(3,720
)
 
(8.8
)%
Occupancy
10,037

 
8,991

 
1,046

 
11.6
 %
Communications and technology
5,552

 
5,064

 
488

 
9.6
 %
FDIC assessment
1,752

 
1,248

 
504

 
40.4
 %
Advertising and public relations
611

 
663

 
(52
)
 
(7.8
)%
Other real estate owned expenses, net
374

 
71

 
303

 
N/M

Impairment of other real estate

 
436

 
(436
)
 
N/M

Amortization of other intangible assets
3,176

 
3,235

 
(59
)
 
(1.8
)
Professional fees
4,214

 
1,170

 
3,044

 
N/M

Acquisition expense, including legal
549

 
14,987

 
(14,438
)
 
(96.3
)
Other
9,443

 
8,350

 
1,093

 
13.1

Total noninterest expense
$
74,368

 
$
86,595

 
$
(12,227
)
 
(14.1
)%
____________
N/M - not meaningful
Salaries and employee benefits. Salaries and employee benefits decreased $3.7 million, or 8.8% for the three months ended March 31, 2020 compared to the same period in 2019. The higher salaries and benefits expense in first quarter 2019
resulted from additional headcount as well as severance and retention expense incurred totaling $3.2 million related to employees not retained from the Guaranty acquisition that closed January 1, 2019 and our second quarter 2019 branch restructuring.
Occupancy.  Occupancy expenses increased $1.0 million, or 11.6% for the three months ended March 31, 2020 compared to the same period in 2019. Occupancy expenses were higher in first quarter 2020 due to higher depreciation and property tax expense related to our new corporate headquarters, which was placed in service in second quarter 2019.
Professional fees. Professional fees increased $3.0 million for the three months ended March 31, 2020compared to the same period in 2019. Professional fees increased due to higher legal expenses related to ongoing acquired litigation, and increased consulting expenses related to a compliance project and new system implementations.
Acquisition expenses. Acquisition expenses decreased $14.4 million for the three months ended March 31, 2020 compared to the same period in 2019. Acquisition expenses were higher in first quarter 2019 due primarily to $8.7 million in change in control payments as well as increased professional fees, contract termination fees and conversion-related expenses related to Guaranty.
Other noninterest expense. Other noninterest expense increased $1.1 million, or 13.1% for the three months ended March 31, 2020 compared to the same period in 2019. The increase in other noninterest expense was due to higher loan-related expenses as well as an impairment charge of $126 thousand on a CRA SBIC fund recognized in first quarter 2020.

48






Income Tax Expense
Income tax expense was $10.8 million for the three months ended March 31, 2020 and $11.1 million for the same period in 2019. The effective tax rate was 19.7% for the three months ended March 31, 2020 compared to 23.1% for the same period in 2019. The lower effective tax rate for the three months ended March 31, 2020 is primarily a result of an $856 thousand tax benefit recorded due to the net operating loss carryback provision allowed through the enactment of the CARES Act, while the higher effective tax rate in 2019 is 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 March 31, 2020 and December 31, 2019.
Assets
The Company’s total assets increased by $615.7 million, or 4.1%, to $15.6 billion as of March 31, 2020 from $15.0 billion at December 31, 2019. The increase is due to organic growth for the period.
Loan Portfolio
The Company’s loan portfolio is the largest category of the Company’s earning assets. The following table presents the balance and associated percentage of each major category in the Company's loan portfolio as of March 31, 2020 and December 31, 2019:
 
 
(dollars in thousands)
March 31, 2020
 
December 31, 2019
Commercial (1)
$
2,611,183

 
22.0
%
 
$
2,482,356

 
21.3
%
Real estate:
 
 
 
 
 
 
 
Commercial
5,873,267

 
49.5

 
5,872,653

 
50.4

Commercial construction, land and land development
1,265,182

 
10.7

 
1,236,623

 
10.6

Residential (2)
1,575,262

 
13.3

 
1,550,872

 
13.3

Single-family interim construction
381,125

 
3.2

 
378,120

 
3.2

Agricultural
97,491

 
0.9

 
97,767

 
0.9

Consumer
52,341

 
0.4

 
32,603

 
0.3

Other
1,105

 

 
621

 

   
11,856,956

 
100.0
%
 
11,651,615

 
100.0
%
Deferred loan fees
(854
)
 
 
 
(1,695
)
 
 
Allowance for loan losses
(58,403
)
 
 
 
(51,461
)
 
 
Total loans, net
$
11,797,699

 
 
 
$
11,598,459

 
   
____________
(1) Includes mortgage warehouse purchase loans of $796.6 million and $687.3 million at March 31, 2020 and December 31, 2019, respectively.
(2) Includes loans held for sale of $39.4 million and $35.6 million at March 31, 2020 and December 31, 2019, respectively.
As of March 31, 2020 and December 31, 2019, total loans, net of allowance for loan losses and deferred fees, totaled $11.8 billion and $11.6 billion, respectively, which is an increase of 1.7% between the two dates. The increase is primarily due to the growth of the mortgage warehouse purchase loan's line of business due to the Company's focused attention to grow the line during 2019 and the higher volumes during first quarter 2020 due to the low mortgage rate environment, in addition to general organic loan growth.

49






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.
Placing a loan on nonaccrual status has a two-fold impact on net interest earnings. First, it may cause a charge against earnings for the interest which had been accrued in the current year but not yet collected on the loan. Second, it eliminates future interest income with respect to that particular loan from the Company’s revenues. Interest on such loans are not recognized until the entire principal is collected or until the loan is returned to performing status.
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.
The Company obtains appraisals of real property that secure loans and may update such appraisals of real property securing loans categorized as nonperforming loans and potential problem loans, in each case as required by regulatory guidelines. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible write-downs or appropriate additions to the allowance for loan losses.
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.

50






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)
 
March 31, 2020
 
December 31, 2019
Nonaccrual loans
 
   
 
   
Commercial
 
$
18,571

 
$
3,130

Real estate:
 
 
 
 
Commercial real estate, construction, land and land development
 
4,483

 
6,461

Residential real estate
 
2,249

 
1,820

Agricultural
 

 
114

Consumer
 
20

 
22

Total nonaccrual loans (1)
 
25,323

 
11,547

Loans delinquent 90 days or more and still accruing
 
   

 
 
Commercial
 
618

 
14,529

Real estate:
 
   

 
 
Residential real estate
 
500

 

Consumer
 
12

 

Total loans delinquent 90 days or more and still accruing
 
1,130

 
14,529

Troubled debt restructurings, not included in nonaccrual loans
 
   

 
 
Real estate:
 
 
 
 
Commercial real estate, construction, land and land development
 
1,855

 
352

Residential real estate
 
185

 
188

Total troubled debt restructurings, not included in nonaccrual loans
 
2,040

 
540

Total nonperforming loans
 
28,493

 
26,616

Other real estate owned and other repossessed assets:
 
   

 
   

Real estate:
 
   

 
 
Commercial real estate, construction, land and land development
 
2,519

 
4,819

Single family interim construction
 
475

 

Consumer
 
114

 
114

Total other real estate owned and other repossessed assets
 
3,108

 
4,933

Total nonperforming assets
 
$
31,601

 
$
31,549

Ratio of nonperforming loans to total loans held for investment (2)
 
0.26
%
 
0.24
%
Ratio of nonperforming assets to total assets
 
0.20

 
0.21

____________
(1)  
Nonaccrual loans include troubled debt restructurings of $646 thousand and $668 thousand at March 31, 2020 and December 31, 2019, respectively and excludes loans acquired with deteriorated credit quality of $17.0 million and $10.9 million as of March 31, 2020 and December 31, 2019, respectively.
(2)  
Excluding mortgage warehouse purchase loans of $796.6 million and $687.3 million as of March 31, 2020 and December 31, 2019, respectively.
Nonaccrual loans increased to $25.3 million at March 31, 2020 from $11.5 million as of December 31, 2019. Troubled debt restructurings that were not on nonaccrual status totaled $2.0 million at March 31, 2020, increasing from $540 thousand at December 31, 2019. The increase in nonaccrual loans was primarily due to a $14.5 million commercial energy loan, reflected in loans 90 days past due and still accruing as of December 31, 2019, as well as a $1.7 million commercial loan, offset by a $1.1 million energy credit paydown and partial charge-off and a $1.9 million single family construction loan placed in foreclosure during the three months ended March 31, 2020.
The increase in troubled debt restructurings was primarily due to a $1.5 million commercial real estate loan modified during Q1 2020.
The net decrease in other real estate owned and repossessed assets is primarily due to the sale of two properties totaling $2.3 million offset by the addition of two properties totaling $476 thousand.

51






As of March 31, 2020, the Company had a total of 79 substandard and doubtful loans with an aggregate principal balance of $55.5 million that were not currently impaired loans or purchase credit 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 as 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 March 31, 2020, the allowance for loan losses amounted to $58.4 million, or 0.53% of total loans held for investment, excluding mortgage warehouse purchase loans, compared with $51.5 million, or 0.47% as of December 31, 2019. The dollar and percentage increases from year end is primarily due to the addition of general reserves for economic concerns related to the COVID-19 pandemic and organic loan growth as well as a $2.8 million specific reserve placed on an energy credit.
The allowance for loan losses to nonperforming loans has increased from 193.35% at December 31, 2019 to 204.97% at March 31, 2020. Nonperforming loans have increased to $28.5 million at March 31, 2020 compared to $26.6 million at December 31, 2019.
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 $356 thousand on the sale of securities for the three months ended March 31, 2020 and a net gain of $245 thousand on the sale of securities for the three month ended March 31, 2019. Securities represented 7.0% and 7.3% of the Company’s total assets at March 31, 2020 and December 31, 2019, respectively.
Certain investment securities are valued at less than their historical cost. 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 March 31, 2020 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 March 31, 2020, 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 $2.4 billion at March 31, 2020 compared to $2.3 billion at December 31, 2019, an increase of approximately $46.5 million. The increase was primarily due to net income of $44.2 million earned by the Company during the three months ended March 31, 2020, stock based compensation of $1.9 million and an increase of $11.4 million in unrealized gain on available for sale securities offset by stock repurchased by the Company totaling $145 thousand and dividends paid of $10.8 million.
 

52






As of March 31, 2020, the Company exceeded all Basel III capital ratio requirements under prompt corrective action and other regulatory requirements, as detailed in the table below:   
 
As of March 31, 2020
 
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
9.67
%
 
10.88
%
 
4.00
%
 
≥5.00%
Common equity tier 1 capital to risk weighted assets ratio
9.95

 
11.67

 
7.00

 
≥6.50
Tier 1 capital to risk weighted assets ratio
10.38

 
11.67

 
8.50

 
≥8.00
Total capital to risk weighted assets ratio
12.05

 
12.12

 
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 $75.0 million of its common stock and was authorized to continue through October 1, 2019. On October 17, 2019, the repurchase program was renewed and authorized to continue through December 31, 2020. As of December 31, 2019, the Company repurchased a total of 897,738 shares of Company stock at a total cost of $49.0 million under this program. No repurchases were made during the period ended March 31, 2020.
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 March 31, 2020, the Company had established federal funds lines of credit with nine unaffiliated banks totaling $365.0 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 $594.0 million with none outstanding as of March 31, 2020. The Company has an unsecured line of credit totaling $100.0 million with an unrelated commercial bank. There were no borrowings against the line as of March 31, 2020. Based on the values of stock, securities, and loans pledged as collateral, as of March 31, 2020, the Company had additional borrowing capacity with the FHLB of $3.0 billion. In addition, the Company maintains a secured line of credit with the Federal Reserve Bank with an availability to borrow $855.1 million at March 31, 2020.

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In April 2020, the Company began originating loans to qualified small businesses under the CARES Act PPP administered by the SBA. Through April 27, 2020, the Company had received SBA authorization for over 4,600 PPP loans totaling over $730 million in aggregate for existing customers. During April 2020, the Company has borrowed $300.0 million from the FHLB to provide supplemental funding for the PPP loan originations. The short-term, full-recourse advance has a term of three months and bears interest at an annualized rate of 0.35%. The Company is also participating in the Federal Reserve's PPP Facility, which, through September 30, 2020, will extend loans to banks who are loaning money to small businesses under the PPP. The amounts borrowed under the facility will be non-recourse and secured by and limited to the amount of the PPP loans originated. The maturity date of a borrowing under the PPP Facility is equal to the maturity date of the PPP loan pledged to secure the borrowing. Borrowings under the PPP Facility will bear interest at a rate of 0.35%. Federal bank regulatory agencies have issued an interim final rule that permits banks to neutralize the regulatory capital effects of participating in the PPP through the PPP Facility. Specifically, all PPP loans will have a zero percent risk weight under applicable risk-based capital rules. Additionally, a bank may exclude all PPP loans pledged as collateral to the PPP Facility from its average total consolidated assets for the purposes of calculating its leverage ratio, while PPP loans that are not pledged as collateral to the PPP Facility will be included.
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.
Other than normal changes in the ordinary course of business, there have been no significant changes in the types of contractual obligations or amounts due since December 31, 2019.
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 $2.2 billion and $25.9 million, respectively, as of March 31, 2020. 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.

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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.
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 still 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.

55






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.
ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires a new credit loss methodology, the current expected credit loss (CECL) model, became effective for the Company on January 1, 2020. As provided to financial institutions under the CARES Act, the Company elected to defer the adoption of the CECL accounting standard and has continued its consistent application of the incurred loss method. Refer to Note 1, Summary of Significant Accounting Policies, in the notes to the Company's consolidated financial statements included elsewhere in this report for additional information.
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 quantitative impairment test is unnecessary. If the Company concludes otherwise, then it is required to perform an 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. During the period ended March 31, 2020, the economic turmoil and market volatility resulting from the coronavirus (COVID-19) pandemic crisis resulted in a substantial decrease in the Company's stock price and market capitalization. Management believed such decrease was a triggering indicator requiring an interim goodwill impairment quantitative analysis which resulted in no impairment charge for the period ended March 31, 2020. Refer to Note 1, Summary of Significant Accounting Policies, in the notes to the Company's consolidated financial statements included elsewhere in this report for additional information.
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.
Recently Issued Accounting Pronouncements
The Company has evaluated new accounting pronouncements that have recently been issued and have determined that there are no new accounting pronouncements that should be described in this section that will materially impact the Company’s operations, financial condition or liquidity in future periods. Refer to Note 1, Summary of Significant Accounting Policies, of the Company’s consolidated financial statements for a discussion of recent accounting pronouncements that have been adopted by the Company or that will require enhanced disclosures in the Company’s financial statements in future periods.


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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 an asset neutral position in terms of interest rate sensitivity as of March 31, 2020. 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 March 31, 2020:
Hypothetical Shift in
Interest Rates (in bps)
% Change in Projected
Net Interest Income
200
2.93%
100
1.46
(100)
(2.14)
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. Due to agreed upon extensions of discovery on July 25, 2019, the Court amended the scheduling order to provide that the case be ready for trial on January 11, 2021. In light of additional agreed upon extensions of discovery deadlines, the Court entered a new scheduling order on March 9, 2020, which now provides that the case be ready for trial March 15, 2021. 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.

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Independent Bank notified its insurance carriers of the claims made in the Second Amended Complaint. The insurance carriers have initially indicated that the claims are 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.
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 the Company's common stock, 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, as amended, for the year ended December 31, 2019, and in the information contained in this Quarterly Report on Form 10-Q and our other reports and registrations statements.
In addition to the risk factors disclosed in these reports and registration statements, you should note the following additional risk factor:
The recent global coronavirus pandemic is likely to impact the financial condition and earnings prospects of the Company.
In December 2019, a novel strain of coronavirus, COVID-19, was reported in Wuhan, China. The coronavirus has since spread rapidly to many other countries, including the United States, and the World Health Organization formally declared the coronavirus outbreak a pandemic in March 2020. In response, federal and many state governments, including Colorado and Texas, have implemented “stay at home” orders restricting the operations of businesses and the activities of individuals. These orders and other effects of the coronavirus pandemic have had significant and widespread effects on the macroeconomic environment, leading to lower interest rates, depressed market valuations, heightened unemployment, heightened volatility in the financial, commodities (including oil and gas) and other markets, and significant disruption in banking and other financial activity in the areas in which the Company operates. The pandemic has also had a significant economic impact on a broad range of industries in which the customers of the Company operate. If the effects of the outbreak are prolonged or result in a lengthy recession, the risk factors set forth in the Company's Form 10-K could be exacerbated.
The coronavirus pandemic has created heightened credit risk. The financial performance of the Company is dependent upon the ability of borrowers to repay their loans and the value of the collateral supporting loans. The outbreak has caused and is likely to cause significant disruption in the business of our customers. Continued unfavorable market conditions and uncertainty due to the coronavirus pandemic may result in a deterioration in the credit quality of borrowers, an increase in the number of loan delinquencies, defaults and charge-offs, additional provisions for loan losses, adverse asset values of the collateral securing loans and an overall material adverse effect on the quality of the loan portfolio of the Company. Various state governments and federal agencies are requiring lenders to provide forbearance and other relief to borrowers. These regulatory programs and governmental policy, including the CARES Act Paycheck Protection Program (PPP) in which the Company is participating, may impact the Company’s ability to resolve credit delinquencies as well as create heightened litigation risk and risk of holding PPP loans at unfavorable interest rates.
In addition, following the coronavirus outbreak, market interest rates have declined significantly to historic lows. The reductions in interest rates, and continued fluctuations in the interest rate environment as a result of changes in monetary policies of the Federal Reserve Board, including in connection with efforts to address the economic fallout from the coronavirus outbreak, could have significant adverse effects on the yields received by the Company on its earning assets and otherwise compress the Company’s net interest margin which is an important component of the Company’s earnings. Continued volatility in interest rates could have a significant adverse effect on the Company’s earnings, financial condition and results of operations.

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The spread of the coronavirus has caused the Company to change its business operations, including adopting a “drive thru banking” model at branch facilities and implementation of a work from home model for non-branch personnel. These changes may have detrimental impacts on the Company’s business due to reduced effectiveness of operations, unavailability of personnel, and increased cybersecurity risks related to the use of remote technology. The change in business operations and continued market uncertainty could also have a detrimental effect on the Company’s relationship with its customers as well as reduce demand for loans and other products and services offered by the Company upon which it relies to drive growth.
The extent to which the coronavirus pandemic impacts our business will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus pandemic and the actions required to contain and treat it, reactions by companies, clients, investors, governmental entities and financial, commodities (including oil and gas) and other markets to such actions, and the effect of the pandemic on short- and long-term general economic conditions, among other factors. There can be no assurance that efforts by the Company to address the adverse impacts of the coronavirus will be effective. If the significant effects of the outbreak are prolonged and if the Company is unable to recover from this business disruption on a timely basis, the Company’s business, financial condition and results of operations may be significantly adversely affected.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Share Repurchase Program The Company established a share repurchase program which allows the Company to purchase its common stock in the open market or in privately negotiated transactions. In general, the share repurchase program allows the Company to proactively manage its capital position and return excess capital to shareholders. This program is described in Note 1, Summary of Significant Accounting Policies, to the Company's consolidated financial statements included elsewhere in this report.
The following table summarizes the Corporation's repurchase activity during the three months ended March 31, 2020.
 
Total Number of Shares Purchased (1)
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Repurchase Plan
Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plan (thousands)
January 2020
112

$
54.21


$
25,952

February 2020
2,517

55.40


25,952

March 2020



25,952

Total first quarter 2020
2,629

$
55.35


$
25,952

____________
(1)
Includes 2,629 shares purchased in connection with the vesting of restricted stock replacement awards acquired with the Guaranty merger. These transactions are not considered part of the Corporation's repurchase program.

Item 3. DEFAULTS UPON SENIOR SECURITIES
None

Item 4. MINE SAFETY DISCLOSURES
Not applicable


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Item 5. OTHER INFORMATION
None


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Item 6. EXHIBITS
The following documents are filed as exhibits to this Quarterly Report on Form 10-Q:
   
 
 
 
Exhibit 3.1
   
   
   
Exhibit 3.2
   
   
   
Exhibit 3.3
   
   
   
Exhibit 3.4
 
 
 
 
Exhibit 3.5
 
 
 
Exhibit 3.6
 
 
 
 
Exhibit 3.7
 
 
 
 
Exhibit 3.8
 
 
 
 
Exhibit 3.9
 
 
 
 
Exhibit 3.10
 
 
 
 
Exhibit 3.11
 
 
 
 
Exhibit 3.12
 
 
 
 

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Exhibit 4.1
 
 
 
 
Exhibit 4.2
 
 
 
 
Exhibit 4.3
 
 
 
 
Exhibit 4.4
 
 
 
 
Exhibit 4.5
 
 
 
 
Exhibit 4.6
 
 
 
 
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 4.7(a)
 
 
 
 
Exhibit 4.7(b)
 
 
 
 
Exhibit 4.7(c)
 
 
 
 
Exhibit 4.7(d)
 
 
 
 
Exhibit 10.1
 
 
 
 
Exhibit 31.1*
   
   
   
Exhibit 31.2*
   
   
   
Exhibit 32.1**
   
   
   

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Exhibit 32.2**
   
 
 
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
   
   
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)


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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
   
 
   
   
Independent Bank Group, Inc.
 
   
   
   
Date:
May 1, 2020
   
By: /s/ David R. Brooks
 
   
   
   
 
   
   
David R. Brooks
 
   
   
Chairman, Chief Executive Officer and President
   
Date:
May 1, 2020
   
By: /s/ Michelle S. Hickox
 
   
   
   
 
   
   
Michelle S. Hickox
 
   
   
Executive Vice President
 
   
   
Chief Financial Officer


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