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TEXAS CAPITAL BANCSHARES INC/TX - Quarter Report: 2018 September (Form 10-Q)

Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended September 30, 2018
¨
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 001-34657
 
 
TEXAS CAPITAL BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
 
Delaware
 
75-2679109
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
2000 McKinney Avenue, Suite 700, Dallas, Texas, U.S.A.
 
75201
(Address of principal executive officers)
 
(Zip Code)
214/932-6600
(Registrant’s telephone number,
including area code)
N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
 
ý
 
  
Accelerated Filer
 
¨
 
 
 
 
 
Non-Accelerated Filer
 
¨
 
  
Smaller Reporting Company
 
¨
 
 
 
 
 
 
 
 
Emerging Growth Company
 
¨

 
 
 
 
 

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

On October 17, 2018, the number of shares set forth below was outstanding with respect to each of the issuer’s classes of common stock:

Common Stock, par value $0.01 per share 50,181,585
 


Table of Contents

Texas Capital Bancshares, Inc.
Form 10-Q
Quarter Ended September 30, 2018
Index
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 2.
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.


2

Table of Contents

PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands except share data)
 
September 30,
2018
 
December 31,
2017
 
(Unaudited)
 
 
Assets
 
 
 
Cash and due from banks
$
169,481

 
$
178,010

Interest-bearing deposits in other banks
2,585,570

 
2,697,581

Federal funds sold and securities purchased under resale agreements
30,000

 
30,000

Investment securities
117,389

 
23,511

Loans held for sale ($1,651.9 million and $1,007.7 million at September 30, 2018 and December 31, 2017, respectively, at fair value)
1,651,930

 
1,011,004

Loans held for investment, mortgage finance
5,477,787

 
5,308,160

Loans held for investment (net of unearned income)
16,569,538

 
15,366,252

Less: Allowance for loan losses
190,306

 
184,655

Loans held for investment, net
21,857,019

 
20,489,757

Mortgage servicing rights, net
86,359

 
85,327

Premises and equipment, net
24,004

 
25,176

Accrued interest receivable and other assets
586,668

 
516,239

Goodwill and intangible assets, net
18,687

 
19,040

Total assets
$
27,127,107

 
$
25,075,645

Liabilities and Stockholders’ Equity
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
7,031,460

 
$
7,812,660

Interest-bearing
13,354,177

 
11,310,520

Total deposits
20,385,637

 
19,123,180

Accrued interest payable
17,218

 
7,680

Other liabilities
215,909

 
182,212

Federal funds purchased and repurchase agreements
486,818

 
365,040

Other borrowings
3,200,000

 
2,800,000

Subordinated notes, net
281,677

 
281,406

Trust preferred subordinated debentures
113,406

 
113,406

Total liabilities
24,700,665

 
22,872,924

Stockholders’ equity:
 
 
 
Preferred stock, $.01 par value, $1,000 liquidation value:
 
 
 
Authorized shares – 10,000,000
 
 
 
Issued shares – 6,000,000 shares issued at September 30, 2018 and December 31, 2017
150,000

 
150,000

Common stock, $.01 par value:
 
 
 
Authorized shares – 100,000,000
 
 
 
Issued shares – 50,177,677 and 49,643,761 at September 30, 2018 and December 31, 2017, respectively
502

 
496

Additional paid-in capital
965,286

 
961,305

Retained earnings
1,312,038

 
1,090,500

Treasury stock – shares at cost: 417 at September 30, 2018 and December 31, 2017
(8
)
 
(8
)
Accumulated other comprehensive income, net of taxes
(1,376
)
 
428

Total stockholders’ equity
2,426,442

 
2,202,721

Total liabilities and stockholders’ equity
$
27,127,107

 
$
25,075,645

See accompanying notes to consolidated financial statements.

3



TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME – UNAUDITED
(In thousands except per share data)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Interest income
 
 
 
 
 
 
 
Interest and fees on loans
$
291,189

 
$
229,116

 
$
814,500

 
$
607,386

Investment securities
1,161

 
341

 
1,560

 
853

Federal funds sold and securities purchased under resale agreements
1,018

 
642

 
2,808

 
1,606

Interest-bearing deposits in other banks
8,386

 
7,544

 
23,607

 
19,935

Total interest income
301,754

 
237,643

 
842,475

 
629,780

Interest expense
 
 
 
 
 
 
 
Deposits
52,034

 
22,435

 
123,343

 
52,261

Federal funds purchased
1,800

 
891

 
4,434

 
1,869

Other borrowings
10,317

 
4,835

 
24,481

 
9,757

Subordinated notes
4,191

 
4,191

 
12,573

 
12,573

Trust preferred subordinated debentures
1,237

 
930

 
3,457

 
2,641

Total interest expense
69,579

 
33,282

 
168,288

 
79,101

Net interest income
232,175

 
204,361

 
674,187

 
550,679

Provision for credit losses
13,000

 
20,000

 
52,000

 
42,000

Net interest income after provision for credit losses
219,175

 
184,361

 
622,187

 
508,679

Non-interest income
 
 
 
 
 
 
 
Service charges on deposit accounts
3,477

 
3,211

 
9,619

 
9,323

Wealth management and trust fee income
2,065

 
1,627

 
5,996

 
4,386

Bank owned life insurance (BOLI) income
643

 
615

 
1,959

 
1,562

Brokered loan fees
6,141

 
6,152

 
17,124

 
17,639

Servicing income
4,987

 
4,486

 
15,446

 
10,387

Swap fees
1,355

 
647

 
4,269

 
3,404

Other
6,850

 
2,265

 
8,331

 
8,181

Total non-interest income
25,518

 
19,003

 
62,744

 
54,882

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
77,327

 
67,882

 
222,268

 
194,039

Net occupancy expense
8,362

 
6,436

 
22,952

 
19,062

Marketing
10,214

 
7,242

 
29,127

 
18,349

Legal and professional
10,764

 
6,395

 
29,948

 
20,975

Communications and technology
7,435

 
6,002

 
21,211

 
24,414

FDIC insurance assessment
6,524

 
6,203

 
18,884

 
16,800

Servicing related expenses
4,207

 
3,897

 
12,379

 
8,329

Allowance and other carrying costs for other real estate owned (OREO)
(1,864
)
 
105

 
467

 
315

Other
13,174

 
10,668

 
37,998

 
30,455

Total non-interest expense
136,143

 
114,830

 
395,234

 
332,738

Income before income taxes
108,550

 
88,534

 
289,697

 
230,823

Income tax expense
22,998

 
29,850

 
60,764

 
78,502

Net income
85,552

 
58,684

 
228,933

 
152,321

Preferred stock dividends
2,438

 
2,438

 
7,313

 
7,313

Net income available to common stockholders
$
83,114

 
$
56,246

 
$
221,620

 
$
145,008

Other comprehensive income (loss)
 
 
 
 
 
 
 
Change in net unrealized gain (loss) on available-for-sale debt securities arising during period, before-tax
$
(2,223
)
 
$
52

 
$
(2,390
)
 
$
22

Income tax expense (benefit) related to net unrealized gain on available-for-sale debt securities
(467
)
 
18

 
(502
)
 
8

Other comprehensive income (loss), net of tax
(1,756
)
 
34

 
(1,888
)
 
14

Comprehensive income
$
83,796

 
$
58,718

 
$
227,045

 
$
152,335

 
 
 
 
 
 
 
 
Basic earnings per common share
$
1.66

 
$
1.13

 
$
4.45

 
$
2.93

Diluted earnings per common share
$
1.65

 
$
1.12

 
$
4.41

 
$
2.89

See accompanying notes to consolidated financial statements.

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Table of Contents

TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY - UNAUDITED
(In thousands except share data)
 
Preferred Stock
 
Common Stock
 
 
 
 
 
Treasury Stock
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Shares
 
Amount
 
Accumulated
Other
Comprehensive
Income (Loss),
Net of Taxes
 
Total
Balance at December 31, 2016 (audited)
6,000,000

 
$
150,000

 
49,504,079

 
$
495

 
$
955,468

 
$
903,187

 
(417
)
 
$
(8
)
 
$
415

 
$
2,009,557

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 
152,321

 

 

 

 
152,321

Change in unrealized gain on available-for-sale securities, net of taxes of $8

 

 

 

 

 

 

 

 
14

 
14

Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
152,335

Stock-based compensation expense recognized in earnings

 

 

 

 
5,717

 

 

 

 

 
5,717

Preferred stock dividend

 

 

 

 

 
(7,313
)
 

 

 

 
(7,313
)
Issuance of stock related to stock-based awards

 

 
84,568

 
1

 
(1,934
)
 

 

 

 

 
(1,933
)
Issuance of common stock related to warrants

 

 
33,595

 

 

 

 

 

 

 

Balance at September 30, 2017
6,000,000

 
$
150,000

 
49,622,242

 
$
496

 
$
959,251

 
$
1,048,195

 
(417
)
 
$
(8
)
 
$
429

 
$
2,158,363

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017 (audited)
6,000,000

 
$
150,000

 
49,643,761

 
$
496

 
$
961,305

 
$
1,090,500

 
(417
)
 
$
(8
)
 
$
428

 
$
2,202,721

Impact of adoption of new accounting standards(1)

 

 

 

 

 
(82
)
 

 

 
84

 
2

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 
228,933

 

 

 

 
228,933

Change in unrealized gain/loss on available-for-sale debt securities, net of taxes of $502

 

 

 

 

 

 

 

 
(1,888
)
 
(1,888
)
Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
227,045

Stock-based compensation expense recognized in earnings

 

 

 

 
6,383

 

 

 

 

 
6,383

Preferred stock dividend

 

 

 

 

 
(7,313
)
 

 

 

 
(7,313
)
Issuance of stock related to stock-based awards

 

 
97,061

 
1

 
(2,397
)
 

 

 

 

 
(2,396
)
Issuance of common stock related to warrants

 

 
436,855

 
5

 
(5
)
 

 

 

 

 

Balance at September 30, 2018
6,000,000

 
$
150,000

 
50,177,677

 
$
502

 
$
965,286

 
$
1,312,038

 
(417
)
 
$
(8
)
 
$
(1,376
)
 
$
2,426,442

(1)
Represents the impact of adopting Accounting Standard Update ("ASU") 2018-02 and ASU 2016-01. See Note 1 to the consolidated financial statements for more information.
See accompanying notes to consolidated financial statements.

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TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS—UNAUDITED
(In thousands) 
 
Nine months ended September 30,
 
2018
 
2017
Operating activities
 
 
 
Net income
$
228,933

 
$
152,321

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
52,000

 
42,000

Depreciation and amortization
24,776

 
19,624

Increase (decrease) in valuation allowance on mortgage servicing rights
(2,823
)
 
216

Bank owned life insurance (BOLI) income
(1,959
)
 
(1,562
)
Stock-based compensation expense
15,633

 
15,021

Purchases and originations of loans held for sale
(5,012,188
)
 
(4,315,065
)
Proceeds from sales and repayments of loans held for sale
4,321,485

 
4,282,910

Proceeds from sale of MSRs
22,439

 

Net loss on sale of loans held for sale and other assets
8,182

 
1,005

Technology write-off

 
5,285

Changes in operating assets and liabilities:
 
 
 
Accrued interest receivable and other assets
(79,107
)
 
(68,672
)
Accrued interest payable and other liabilities
33,920

 
8,434

Net cash provided by (used in) operating activities
(388,709
)
 
141,517

Investing activities
 
 
 
Purchases of available-for-sale investment securities
(99,295
)
 
(97,381
)
Maturities and calls of available-for-sale securities

 
94,775

Principal payments received on available-for-sale securities
2,998

 
3,278

Originations of mortgage finance loans
(73,661,362
)
 
(62,284,036
)
Proceeds from pay-offs of mortgage finance loans
73,491,735

 
61,139,089

Net increase in loans held for investment, excluding mortgage finance loans
(1,248,423
)
 
(1,856,253
)
Purchase of premises and equipment, net
(5,655
)
 
(9,056
)
Proceeds from sale of foreclosed assets, net
13,645

 
767

Net cash used in investing activities
(1,506,357
)
 
(3,008,817
)
Financing activities
 
 
 
Net increase in deposits
1,262,457

 
2,064,426

Costs from issuance of stock related to stock-based awards and warrants
(2,396
)
 
(1,933
)
Preferred dividends paid
(7,313
)
 
(7,313
)
Net increase in other borrowings
400,000

 
500,000

Net increase in Federal funds purchased and repurchase agreements
121,778

 
(26,079
)
Net cash provided by financing activities
1,774,526

 
2,529,101

Net decrease in cash and cash equivalents
(120,540
)
 
(338,199
)
Cash and cash equivalents at beginning of period
2,905,591

 
2,839,352

Cash and cash equivalents at end of period
$
2,785,051

 
$
2,501,153

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for interest
$
158,750

 
$
80,037

Cash paid during the period for income taxes
64,225

 
72,485

Transfers from loans/leases to OREO and other repossessed assets

 

See accompanying notes to consolidated financial statements.

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TEXAS CAPITAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—UNAUDITED
(1) OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Business
Texas Capital Bancshares, Inc. (the “Company”), a Delaware corporation, was incorporated in November 1996 and commenced banking operations in December 1998. The consolidated financial statements of the Company include the accounts of Texas Capital Bancshares, Inc. and its wholly owned subsidiary, Texas Capital Bank, National Association (the “Bank”). We serve the needs of commercial businesses and successful professionals and entrepreneurs located in Texas as well as operate several lines of business serving a regional and national clientèle of commercial borrowers. We are primarily a secured lender with a majority of our loans being made to businesses headquartered or with operations in Texas. At the same time, our national lines of business continue to provide specialized lending products,as well as treasury services, deposit products and other complementary banking services, to businesses throughout the United States.
Basis of Presentation
Our accounting and reporting policies conform to accounting principles generally accepted in the United States (“GAAP”) and to generally accepted practices within the banking industry. Certain prior period balances have been reclassified to conform to the current period presentation.
The consolidated interim financial statements are unaudited and certain information and footnote disclosures presented in accordance with GAAP have been condensed or omitted. In the opinion of management, the interim financial statements include all normal and recurring adjustments and the disclosures made are adequate to make the interim financial information not misleading. The consolidated financial statements have been prepared in accordance with GAAP for interim financial information and the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2017, included in our Annual Report on Form 10-K filed with the SEC on February 14, 2018 (the “2017 Form 10-K”). Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.
Accounting Changes
ASU 2018-02 "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" ("ASU 2018-02") allows a reclassification from accumulated other comprehensive income (loss) ("AOCI") to retained earnings for the stranded tax effects caused by the revaluation of deferred taxes resulting from the newly enacted corporate tax rate in the Tax Cuts and Jobs Act. The ASU is effective in years beginning after December 15, 2018, but permits early adoption in a period for which financial statements have not yet been issued. We have elected to early adopt the ASU as of January 1, 2018. The adoption of the guidance resulted in an insignificant cumulative-effect adjustment that decreased retained earnings and increased AOCI in the first quarter of 2018.
ASU 2016-15 "Statement of Cash Flows (Topic 230)" ("ASU 2016-15") is intended to reduce the diversity in practice around how certain transactions are classified within the statement of cash flows. ASU 2016-15 became effective for us on January 1, 2018 and did not have a significant impact on our financial statements.
ASU 2016-01 "Financial Instruments - Overall (Subtopic 825-10): Recognition of Financial Assets and Financial Liabilities, ("ASU 2016-01") makes targeted amendments to the guidance for recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 requires equity investments, other than equity method investments, to be measured at fair value with changes in fair value recognized in net income. The ASU requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption to reclassify the cumulative change in fair value of equity securities previously recognized in AOCI. ASU 2016-01 became effective for us on January 1, 2018. The adoption of the guidance resulted in an insignificant cumulative-effect adjustment that increased retained earnings, with offsetting related adjustments to deferred taxes and AOCI. ASU 2016-01 also emphasizes the existing requirement to use exit prices to measure fair value for disclosure purposes and clarifies that entities should not make use of a practicability exception in determining the fair value of loans. Accordingly, we refined the calculation used to determine the disclosed fair value of our loans held for investment portfolio as part of adopting this standard. The refined calculation did not have a significant impact on our fair value disclosures. See Note 11 - Fair Value Disclosures.

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ASU 2014-09 "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09") implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 establishes a five-step model which entities must follow to recognize revenue and removes inconsistencies and weaknesses in existing guidance. The guidance does not apply to revenue associated with financial instruments, including loans and investment securities that are accounted for under other GAAP, which comprises a significant portion of our revenue stream. ASU 2014-09 became effective for us on January 1, 2018 and had no material effect on how we recognize revenue or to our consolidated financial statements and disclosures. See below for additional information related to revenue generated from contracts with customers.
Revenue Recognition
Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606"), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.
The majority of our revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as our loans, letters of credit, derivatives and investment securities, as well as revenue related to our mortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere within our disclosures. Descriptions of our revenue-generating activities that are within the scope of ASC 606, which are presented in our income statements as components of non-interest income are as follows:
Service charges on deposit accounts - these represent general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payments for such performance obligations are generally received at the time the performance obligations are satisfied.
Wealth management and trust fee income - this represents monthly fees due from wealth management customers as consideration for managing the customers' assets. Wealth management and trust services include custody of assets, investment management, escrow services, fees for trust services and similar fiduciary activities. Revenue is recognized when our performance obligation is completed each month, which is generally the time that payment is received. Also included are fees received from third party broker-dealers as part of a revenue-sharing agreement for fees earned from customers that we refer to the third party. These fees are paid to us by the third party on a quarterly basis and recognized ratably throughout the quarter as our performance obligation is satisfied.
Brokered loan fees - these represent fees for the administration and funding of purchased mortgage loan interests as well as facility renewal and application fees received from mortgage originator customers in our warehouse lending business. Also included are fees received from independent correspondent mortgage lenders as consideration for our purchase of individual residential mortgage loans through our Mortgage Correspondent Aggregation ("MCA") business. Revenue related to the warehouse lending business is recognized when the related loan interest is disposed (i.e., through sale or payoff) or upon receipt of the facility renewal or application. Revenue related to our MCA business is recognized at the time a loan is purchased.
Other non-interest income primarily includes items such as letter of credit fees, gains on sale of loans held for sale and servicing fees related to the MCA program, none of which are subject to the requirements of ASC 606.
Investment Securities
Investment securities include available-for-sale debt securities and equity securities at fair value.
Debt Securities
Debt securities are classified as trading, available-for-sale or held-to-maturity. Management classifies debt securities at the time of purchase and re-assesses such designation at each balance sheet date; however, transfers between categories from this re-assessment are rare.

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Trading Account
Debt securities acquired for resale in anticipation of short-term market movements are classified as trading, with realized and unrealized gains and losses recognized in income. To date, we have not had any activity in our trading account.
Held-to-Maturity
Debt securities are classified as held to maturity when we have the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity or trading are classified as available-for-sale.
Available-for-Sale
Available-for-sale debt securities are stated at fair value, with the unrealized gains and losses reported as a separate component of AOCI, net of tax. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization and accretion is included in interest income from securities. Realized gains and losses and declines in value judged to be other-than-temporary are included in gain (loss) on sale of securities. In estimating other-than-temporary impairment losses, we consider, among other things, length of time and the extent to which the fair value have been less than cost, the financial condition and near-term prospects of the issuer and the intent and our ability to retain our investment in the issuer for a period of time sufficient to allow for any time anticpated recovery in fair value. The cost of securities sold is based on the specific identification method.
All debt securities are available-for-sale as of September 30, 2018 and December 31, 2017.
Equity Securities
Beginning January 1, 2018, upon adoption of ASU 2016-01, equity securities with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in other non-interest income in the consolidated statements of income and other comprehensive income. For periods prior to January 1, 2018, equity securities were classified as available-for-sale and stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. Equity securities without readily determinable fair values are recorded at cost less any impairment, if any.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for loan losses, the fair value of stock-based compensation awards, the fair value of mortgage servicing rights ("MSRs") and the status of contingencies are particularly susceptible to significant change.

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Table of Contents


(2) EARNINGS PER COMMON SHARE

The following table presents the computation of basic and diluted earnings per share (in thousands except share data):
 
 
Three months ended 
 September 30,
 
Nine months ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Numerator:
 
 
 
 
 
 
 
Net income
$
85,552

 
$
58,684

 
$
228,933

 
$
152,321

Preferred stock dividends
2,438

 
2,438

 
7,313

 
7,313

Net income available to common stockholders
83,114

 
56,246

 
$
221,620

 
145,008

Denominator:
 
 
 
 
 
 
 
Denominator for basic earnings per share—weighted average shares
50,163,433

 
49,607,028

 
49,853,515

 
49,573,456

Effect of employee stock-based awards(1)
207,391

 
214,468

 
240,376

 
235,011

Effect of warrants to purchase common stock
10,525

 
429,370

 
115,537

 
431,551

Denominator for dilutive earnings per share—adjusted weighted average shares and assumed conversions
50,381,349

 
50,250,866

 
50,209,428

 
50,240,018

Basic earnings per common share
$
1.66

 
$
1.13

 
$
4.45

 
$
2.93

Diluted earnings per common share
$
1.65

 
$
1.12

 
$
4.41

 
$
2.89

 
(1)
SARs and RSUs outstanding of 4,000 at September 30, 2018 and 6,200 at September 30, 2017 have not been included in diluted earnings per share because to do so would have been anti-dilutive for the periods presented.


10

Table of Contents

(3) INVESTMENT SECURITIES
Available-for-Sale Debt Securities
The following is a summary of available-for-sale debt securities (in thousands):
 
September 30, 2018

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair
Value
Residential mortgage-backed securities
$
7,299


$
410

 
$

 
$
7,709

Tax-exempt asset-backed securities
95,521

 

 
(2,152
)
 
93,369

 
$
102,820

 
$
410

 
$
(2,152
)
 
$
101,078

 
 
 
 
 
 
 
 
 
December 31, 2017
 
Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Estimated
Fair
Value
Residential mortgage-backed securities
$
10,297

 
$
648

 
$

 
$
10,945

During the third quarter of 2018, we purchased a $95.5 million tax-exempt security backed with underlying cash flows from municipal revenue bonds. The security was recorded as available-for-sale upon purchase and subsequently marked to fair value as of quarter end.
The amortized cost and estimated fair value of available-for-sale debt securities are presented below by contractual maturity (in thousands, except percentage data): 
 
September 30, 2018

Less Than
One Year

After One
Through
Five Years

After Five
Through
Ten Years

After Ten
Years

Total
Residential mortgage-backed securities:(1)









Amortized cost
12

 
1,727

 

 
5,560

 
7,299

Estimated fair value
13

 
1,846

 

 
5,850

 
7,709

Weighted average yield(3)
6.23
%
 
5.55
%
 
%
 
3.79
%
 
4.21
%
Tax-exempt asset-backed securities:(1)
 
 
 
 
 
 
 
 
 
Amortized cost

 

 

 
95,521

 
95,521

Estimated fair value

 

 

 
93,369

 
93,369

Weighted average yield(2)(3)
%
 
%
 
%
 
4.25
%
 
4.25
%
Total available-for-sale debt securities:
 
 
 
 
 
 
 
 
 
Amortized cost
 
 
 
 
 
 
 
 
$
102,820

Estimated fair value
 
 
 
 
 
 
 
 
$
101,078

 
December 31, 2017

Less Than
One Year

After One
Through
Five Years

After Five
Through
Ten Years

After Ten
Years

Total
Residential mortgage-backed securities:(1)









Amortized cost
$
409

 
$
819

 
$
1,502

 
$
7,567

 
$
10,297

Estimated fair value
418

 
916

 
1,636

 
7,975

 
10,945

Weighted average yield(3)
4.59
%
 
6.02
%
 
5.32
%
 
3.45
%
 
3.97
%
(1)
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
(2)
Yields have been adjusted to a tax equivalent basis assuming a 21% federal tax rate.
(3)
Yields are calculated based on amortized cost.


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Table of Contents

The following table discloses as of September 30, 2018 our available-for-sale debt securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months (in thousands):
September 30, 2018
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Tax-exempt asset-backed
 
 
 
 
 
 
 
 
 
 
 
     securities
$
93,369

 
$
(2,152
)
 
$

 
$

 
$
93,369

 
$
(2,152
)

At September 30, 2018, we had three available-for-sale debt securities in an unrealized loss position. We do not believe these unrealized losses are "other than temporary." We have evaluated the near-term prospects of the investments in relation to the severity and duration of the impairment and based on that evaluation we have determined that we have the ability and intent to hold the investments until recovery of fair value.
At December 31, 2017, we did not have any available-for-sale debt securities in an unrealized loss position.
At September 30, 2018, available-for-sale debt securities with carrying values of $1.9 million and $5.1 million were pledged to secure certain deposits and repurchase agreements, respectively.
Equity Securities
Equity securities consist of Community Reinvestment Act funds and investments related to our non-qualified deferred compensation plan. At September 30, 2018 and December 31, 2017, we had $16.3 million and $12.6 million, respectively, in equity securities recorded at fair value. Prior to January 1, 2018, equity securities were stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. At December 31, 2017, net unrealized gains of $10,000 had been recognized in AOCI. On January 1, 2018, these unrealized gains and losses were reclassified out of AOCI and into retained earnings with subsequent changes in fair value being recognized in other non-interest income. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and nine months ended September 30, 2018 (in thousands):
 
Three months ended
 
Nine months ended
 
September 30, 2018
 
September 30, 2018
Net gains and (losses) recognized during the period on equity securities
$
253

 
$
149

Less: Net gains and (losses) recognized during the period on equity securities sold during the period
18

 
180

Unrealized gains and (losses) recognized during the reporting period on equity securities still held at the reporting date
$
235

 
$
(31
)


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Table of Contents

(4) LOANS HELD FOR INVESTMENT AND ALLOWANCE FOR LOAN LOSSES
At September 30, 2018 and December 31, 2017, loans held for investment were as follows (in thousands):
 
 
September 30,
2018
 
December 31,
2017
Commercial
$
10,116,945

 
$
9,189,811

Mortgage finance
5,477,787

 
5,308,160

Construction
2,263,463

 
2,166,208

Real estate
3,924,682

 
3,794,577

Consumer
51,692

 
48,684

Leases
319,411

 
264,903

Gross loans held for investment
22,153,980

 
20,772,343

Deferred income (net of direct origination costs)
(106,655
)
 
(97,931
)
Allowance for loan losses
(190,306
)
 
(184,655
)
Total loans held for investment, net
$
21,857,019

 
$
20,489,757

Commercial Loans and Leases. Our commercial loan portfolio is comprised of lines of credit for working capital and term loans and leases to finance equipment and other business assets. Our energy production loans are generally collateralized with proven reserves based on appropriate valuation standards and take into account the risk of oil and gas price volatility. Our commercial loans and leases are underwritten after carefully evaluating and understanding the borrower’s ability to operate profitably. Our underwriting standards are designed to promote relationship banking rather than to make loans on a transaction basis. Our lines of credit typically are limited to a percentage of the value of the assets securing the line. Lines of credit and term loans typically are reviewed annually, or more frequently, as needed, and are supported by accounts receivable, inventory, equipment and other assets of our clients’ businesses.
Mortgage Finance Loans. Our mortgage finance loans consist of ownership interests purchased in single-family residential mortgages funded through our mortgage finance group. We have agreements with mortgage lenders and purchase interests in individual loans they originate. The ownership interests collateralizing our mortgage finance loans are typically held on our balance sheet for 10 to 20 days, and substantially all loans are conforming loans. Substantially all mortgage loans are underwritten consistently with established programs for permanent financing with financially sound investors. Balances as of September 30, 2018 and December 31, 2017 are stated net of $174.1 million and $171.2 million of participations sold, respectively.
Construction Loans. Our construction loan portfolio consists primarily of single- and multi-family residential properties and commercial projects used in manufacturing, warehousing, service or retail businesses. Our construction loans generally have terms of one to three years. We typically make construction loans to developers, builders and contractors that have an established record of successful project completion and loan repayment and have a substantial equity investment in the borrowers. Loan amounts are derived primarily from the Bank's evaluation of expected cash flows available to service debt from stabilized projects under hypothetically stressed conditions. Construction loans are also based in part upon estimates of costs and value associated with the completed project. Sources of repayment for these types of loans may be permanent loans from other lenders, sales of developed property, or an interim loan commitment from us until permanent financing is obtained. The nature of these loans makes ultimate repayment sensitive to overall economic conditions. Borrowers may not be able to correct conditions of loan defaults, increasing risk of exposure to classification, non-performing status, reserve allocation and actual credit loss and foreclosure. These loans typically have floating rates and require commitment fees.
Real Estate Loans. A portion of our real estate loan portfolio is comprised of loans secured by properties other than market risk or investment-type real estate. Market risk loans are real estate loans where the primary source of repayment is expected to come from the sale, permanent financing or lease of the real property collateral. We generally provide temporary financing for commercial and residential property. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Our real estate loans generally have maximum terms of five to seven years, and we provide loans with both floating and fixed rates. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Appraised values may be highly variable due to market conditions and the impact of the inability of potential purchasers and lessees to obtain financing and a lack of transactions at comparable values.

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Table of Contents

At September 30, 2018 and December 31, 2017, we had a blanket floating lien on certain real estate-secured loans, mortgage finance loans and certain investment securities used as collateral for Federal Home Loan Bank borrowings.
Summary of Loan Loss Experience
The allowance for loan losses is comprised of general reserves, specific reserves for impaired loans and an additional qualitative reserve based on our estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We consider the allowance at September 30, 2018 to be appropriate, given management's assessment of losses inherent in the portfolio as of the evaluation date, the significant growth in the loan and lease portfolio, current economic conditions in our market areas and other factors.
The following tables summarize the credit risk profile of our loan portfolio by internally assigned grades and non-accrual status as of September 30, 2018 and December 31, 2017 (in thousands):

September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
9,851,525

 
$
5,477,787

 
$
2,250,650

 
$
3,845,393

 
$
50,064

 
$
318,969

 
$
21,794,388

Special mention
96,168

 

 
12,813

 
44,486

 

 
442

 
153,909

Substandard-accruing
64,295

 

 

 
32,288

 
1,568

 

 
98,151

Non-accrual
104,957

 

 

 
2,515

 
60

 

 
107,532

Total loans held for investment
$
10,116,945

 
$
5,477,787

 
$
2,263,463

 
$
3,924,682

 
$
51,692

 
$
319,411

 
$
22,153,980

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
8,967,471

 
$
5,308,160

 
$
2,152,654

 
$
3,706,541

 
$
48,591

 
$
249,865

 
$
20,433,282

Special mention
19,958

 

 
13,554

 
53,652

 

 
495

 
87,659

Substandard-accruing
102,651

 

 

 
32,671

 
93

 
14,543

 
149,958

Non-accrual
99,731

 

 

 
1,713

 

 

 
101,444

Total loans held for investment
$
9,189,811

 
$
5,308,160

 
$
2,166,208

 
$
3,794,577

 
$
48,684

 
$
264,903

 
$
20,772,343


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Table of Contents


The following table details activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2018 and 2017. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Commercial
 
Mortgage
Finance
 
Construction
 
Real
Estate
 
Consumer
 
Leases
 
Additional Qualitative Reserve
 
Total
Beginning balance
$
118,806

 
$

 
$
19,273

 
$
34,287

 
$
357

 
$
3,542

 
$
8,390

 
$
184,655

Provision for loan losses
55,808

 

 
331

 
(1,635
)
 
757

 
(1,425
)
 
(3,048
)
 
50,788

Charge-offs
45,273

 

 

 

 
767

 
319

 

 
46,359

Recoveries
1,069

 

 

 
43

 
78

 
32

 

 
1,222

Net charge-offs (recoveries)
44,204

 

 

 
(43
)
 
689

 
287

 

 
45,137

Ending balance
$
130,410

 
$

 
$
19,604

 
$
32,695

 
$
425

 
$
1,830

 
$
5,342

 
$
190,306

Period end amount allocated to:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$
30,855

 
$

 
$

 
$
70

 
$
10

 
$

 
$

 
$
30,935

Loans collectively evaluated for impairment
99,555

 

 
19,604

 
32,625

 
415

 
1,830

 
5,342

 
159,371

Ending balance
$
130,410

 
$

 
$
19,604

 
$
32,695

 
$
425

 
$
1,830

 
$
5,342

 
$
190,306

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Commercial
 
Mortgage
Finance
 
Construction
 
Real
Estate
 
Consumer
 
Leases
 
Additional Qualitative Reserve
 
Total
Beginning balance
$
128,768

 
$

 
$
13,144

 
$
19,149

 
$
241

 
$
1,124

 
$
5,700

 
$
168,126

Provision for loan losses
21,388

 

 
4,431

 
12,948

 
221

 
2,774

 
1,899

 
43,661

Charge-offs
32,146

 

 
59

 
290

 
180

 

 

 
32,675

Recoveries
3,574

 

 
104

 
74

 
56

 
9

 

 
3,817

Net charge-offs (recoveries)
28,572

 

 
(45
)
 
216

 
124

 
(9
)
 

 
28,858

Ending balance
$
121,584

 
$

 
$
17,620

 
$
31,881

 
$
338

 
$
3,907

 
$
7,599

 
$
182,929

Period end amount allocated to:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$
24,410

 
$

 
$

 
$
26

 
$

 
$

 
$

 
$
24,436

Loans collectively evaluated for impairment
97,174

 

 
17,620

 
31,855

 
338

 
3,907

 
7,599

 
158,493

Ending balance
$
121,584

 
$

 
$
17,620

 
$
31,881

 
$
338

 
$
3,907

 
$
7,599

 
$
182,929

The table below presents the activity in the allowance for off-balance sheet credit losses related to unfunded commitments for the three and nine months ended September 30, 2018 and 2017 (in thousands). This allowance is recorded in other liabilities in the consolidated balance sheet.
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Beginning balance
 
$
10,458

 
$
9,205

 
$
9,071

 
$
11,422

Provision for off-balance sheet credit losses
 
(175
)
 
556

 
1,212

 
(1,661
)
Ending balance
 
$
10,283

 
$
9,761

 
$
10,283

 
$
9,761


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Table of Contents

We have traditionally maintained an additional qualitative reserve component to compensate for the uncertainty and complexity in estimating loan and lease losses including factors and conditions that may not be fully reflected in the determination and application of the allowance allocation percentages. The decrease in the additional qualitative reserve at September 30, 2018 as compared to December 31, 2017 was primarily related to the resolution of remaining uncertainty regarding the impact to our loan portfolio from Hurricanes Harvey and Irma. We believe the level of additional qualitative reserves at September 30, 2018 is warranted due to uncertainties and unpredictable factors that have produced losses, including those resulting from borrowers' misstatement of financial information or inaccurate certification of collateral values. Such losses are not necessarily correlated with historical loss trends or general economic conditions. Our methodology used to calculate the allowance considers historical losses; however, the historical loss rates for specific product types or credit risk grades may not fully incorporate the effects of uncertainties or unpredictable events.
Our recorded investment in loans as of September 30, 2018December 31, 2017 and September 30, 2017 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of our impairment methodology was as follows (in thousands):
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Loans individually evaluated for impairment
$
105,522

 
$

 
$

 
$
9,057

 
$
60

 
$

 
$
114,639

Loans collectively evaluated for impairment
10,011,423

 
5,477,787

 
2,263,463

 
3,915,625

 
51,632

 
319,411

 
22,039,341

Total
$
10,116,945

 
$
5,477,787

 
$
2,263,463

 
$
3,924,682

 
$
51,692

 
$
319,411

 
$
22,153,980

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Loans individually evaluated for impairment
$
100,676

 
$

 
$

 
$
2,008

 
$

 
$

 
$
102,684

Loans collectively evaluated for impairment
9,089,135

 
5,308,160

 
2,166,208

 
3,792,569

 
48,684

 
264,903

 
20,669,659

Total
$
9,189,811

 
$
5,308,160

 
$
2,166,208

 
$
3,794,577

 
$
48,684

 
$
264,903

 
$
20,772,343

 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Loans individually evaluated for impairment
$
117,426

 
$

 
$

 
$
2,117

 
$

 
$

 
$
119,543

Loans collectively evaluated for impairment
8,693,399

 
5,642,285

 
2,099,355

 
3,681,447

 
70,436

 
259,720

 
20,446,642

Total
$
8,810,825

 
$
5,642,285

 
$
2,099,355

 
$
3,683,564

 
$
70,436

 
$
259,720

 
$
20,566,185


We place loans on non-accrual when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, generally when a loan is 90 days past due. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is reversed. Interest income is subsequently recognized on a cash basis as long as the remaining unpaid principal amount of the loan is deemed to be fully collectible. If collectability is questionable, then cash payments are applied to principal. As of both September 30, 2018 and December 31, 2017, none of our non-accrual loans were earning interest income on a cash basis. A loan is placed back on accrual status when both principal and interest are current and it is probable that we will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.

16

Table of Contents

A loan held for investment is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due (both principal and interest) according to the terms of the original loan agreement. In accordance with ASC 310, Receivables, we have also included all restructured and formerly restructured loans in our impaired loan totals. The following tables detail our impaired loans, by portfolio class, as of September 30, 2018 and December 31, 2017 (in thousands):
September 30, 2018
 
 
 
 
 
 
 
 
 
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
14,669

 
$
21,428

 
$

 
$
16,045

 
$
133

Energy
12,777

 
13,953

 

 
18,653

 

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Commercial
7,557

 
7,557

 

 
1,787

 

Secured by 1-4 family
1,263

 
1,263

 

 
561

 

Consumer

 

 

 

 

Leases

 

 

 

 

Total impaired loans with no allowance recorded
$
36,266

 
$
44,201

 
$

 
$
37,046

 
$
133

With an allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
59,618

 
$
78,304

 
$
24,180

 
$
39,880

 
$

Energy
18,458

 
19,718

 
6,675

 
27,312

 

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
66

 

Commercial

 

 

 
111

 

Secured by 1-4 family
237

 
237

 
70

 
171

 

Consumer
60

 
60

 
10

 
53

 

Leases

 

 

 
367

 

Total impaired loans with an allowance recorded
$
78,373

 
$
98,319

 
$
30,935

 
$
67,960

 
$

Combined:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
74,287

 
$
99,732

 
$
24,180

 
$
55,925

 
$
133

Energy
31,235

 
33,671

 
6,675

 
45,965

 

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
66

 

Commercial
7,557

 
7,557

 

 
1,898

 

Secured by 1-4 family
1,500

 
1,500

 
70

 
732

 

Consumer
60

 
60

 
10

 
53

 

Leases

 

 

 
367

 

Total impaired loans
$
114,639

 
$
142,520

 
$
30,935

 
$
105,006

 
$
133


17

Table of Contents

December 31, 2017
 
 
 
 
 
 
 
 
 
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
16,835

 
$
18,257

 
$

 
$
22,964

 
$

Energy
21,426

 
22,602

 

 
36,579

 

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Commercial
1,096

 
1,096

 

 
2,166

 

Secured by 1-4 family

 

 

 

 

Consumer

 

 

 

 

Leases

 

 

 

 

Total impaired loans with no allowance recorded
$
39,357

 
$
41,955

 
$

 
$
61,709

 
$

With an allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
18,645

 
$
19,020

 
$
2,544

 
$
16,960

 
$

Energy
43,770

 
55,875

 
21,772

 
50,867

 
6

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
27

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
295

 
295

 
6

 
485

 

Commercial
499

 
499

 
75

 
166

 

Secured by 1-4 family
118

 
118

 
20

 
516

 

Consumer

 

 

 
33

 

Leases

 

 

 
14

 

Total impaired loans with an allowance recorded
$
63,327

 
$
75,807

 
$
24,417

 
$
69,068

 
$
6

Combined:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
35,480

 
$
37,277

 
$
2,544

 
$
39,924

 
$

Energy
65,196

 
78,477

 
21,772

 
87,446

 
6

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
27

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
295

 
295

 
6

 
485

 

Commercial
1,595

 
1,595

 
75

 
2,332

 

Secured by 1-4 family
118

 
118

 
20

 
516

 

Consumer

 

 

 
33

 

Leases

 

 

 
14

 

Total impaired loans
$
102,684

 
$
117,762

 
$
24,417

 
$
130,777

 
$
6



18

Table of Contents

Average impaired loans outstanding during the nine months ended September 30, 2018 and 2017 totaled $105.0 million and $135.9 million, respectively.
The table below provides an age analysis of our loans held for investment as of September 30, 2018 (in thousands):
 
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater
Than 90
Days and
Accruing(1)
 
Total Past
Due
 
Non-accrual
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Business loans
$
51,154

 
$
4,304

 
$
9,882

 
$
65,340

 
$
73,722

 
$
8,488,962

 
$
8,628,024

Energy
13,000

 
2,281

 

 
15,281

 
31,235

 
1,442,405

 
1,488,921

Mortgage finance loans

 

 

 

 

 
5,477,787

 
5,477,787

Construction
 
 
 
 
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

 
2,182,653

 
2,182,653

Commercial

 

 

 

 

 
53,116

 
53,116

Secured by 1-4 family

 

 

 

 

 
27,694

 
27,694

Real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Market risk
3,471

 

 
1,413

 
4,884

 

 
2,759,177

 
2,764,061

Commercial
4,192

 

 

 
4,192

 
1,015

 
814,646

 
819,853

Secured by 1-4 family
1,538

 
85

 

 
1,623

 
1,500

 
337,645

 
340,768

Consumer

 

 

 

 
60

 
51,632

 
51,692

Leases
92

 

 

 
92

 

 
319,319

 
319,411

Total loans held for investment
$
73,447

 
$
6,670

 
$
11,295

 
$
91,412

 
$
107,532

 
$
21,955,036

 
$
22,153,980

 
(1)
Loans past due 90 days and still accruing includes premium finance loans of $8.2 million. These loans are generally secured by obligations of insurance carriers to refund premiums on canceled insurance policies. The refund of premiums from the insurance carriers can take 180 days or longer from the cancellation date.
Restructured loans are loans on which, due to the borrower’s financial difficulties, we have granted a concession that we would not otherwise consider for borrowers of similar credit quality. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of the two. Modifications of terms that could potentially qualify as a restructuring include reduction of the contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current rate for new debt with similar risk, a reduction of the face amount of debt or forgiveness of either principal or accrued interest. At September 30, 2018 and December 31, 2017, we did not have any loans considered restructured that were not on non-accrual. Of the non-accrual loans at September 30, 2018 and December 31, 2017, $22.5 million and $18.8 million, respectively, met the criteria for restructured. These loans had no unfunded commitments at their respective balance sheet dates. A loan continues to qualify as restructured until a consistent payment history or change in borrower’s financial condition has been evidenced, generally over no less than twelve months. Assuming that the restructuring agreement specifies an interest rate at the time of the restructuring that is greater than or equal to the rate that we are willing to accept for a new extension of credit with comparable risk, then the loan no longer has to be considered a restructuring if it is in compliance with the modified terms in calendar years after the year of the restructure.

19

Table of Contents

The following table summarizes the loans that were restructured during the nine months ended September 30, 2018 and 2017 (in thousands):
 
As of and for the nine months ended September 30, 2018
 
 
 
 
 
 
Number of Restructured Loans
 
Balance at Restructure
 
Balance at Period-End
Energy loans
5

 
$
12,358

 
$
12,332

Commercial business loans
2

 
2,582

 
2,582

Total new restructured loans
7

 
$
14,940

 
$
14,914

 
 
 
 
 
 
As of and for the nine months ended September 30, 2017
 
 
 
 
 
 
Number of Restructured Loans
 
Balance at Restructure
 
Balance at Period-End
Energy loans
1

 
$
1,070

 
$

Commercial business loans
1

 
599

 
721

Total new restructured loans
2

 
$
1,669

 
$
721

The restructured loans generally include terms to temporarily place loans on interest only, extend the payment terms or reduce the interest rate. We did not forgive any principal on the above loans. The restructuring of the loans did not have a significant impact on our allowance for loan losses at September 30, 2018 or 2017.
The following table provides information on how loans were modified as restructured during the nine months ended September 30, 2018 and 2017 (in thousands):
 
 
Nine months ended September 30,
 
2018
 
2017
Extended maturity
$

 
$
721

Adjusted payment schedule
14,914

 

Total
$
14,914

 
$
721

As of September 30, 2018 and 2017, we did not have any loans that were restructured within the last 12 months that subsequently defaulted.
(5) OREO AND VALUATION ALLOWANCE FOR LOSSES ON OREO
The table below presents a summary of the activity related to OREO (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Beginning balance
$
9,526

 
$
18,689

 
$
11,742

 
$
18,961

Additions

 

 

 

Sales
(11,447
)
 
(457
)
 
(11,663
)
 
(729
)
Valuation allowance for OREO
2,000

 
(101
)
 

 
(101
)
Ending balance
$
79

 
$
18,131

 
$
79

 
$
18,131

During the third quarter of 2018, we sold our largest OREO property and recorded a $2.0 million gain on sale, as well as a reversal of a $2.0 million valuation allowance that was recorded on the property during the first quarter of 2018. The gain on sale was recorded in other non-interest income and the reversal of the valuation allowance was recorded in other non-interest expense.
When foreclosure occurs, the acquired asset is recorded at fair value less selling costs, generally based on appraised value, which may result in partial charge-off of the loan. Subsequent write-downs required for declines in value are recorded through a valuation allowance or taken directly against the asset and charged to other non-interest expense.


20



(6) CERTAIN TRANSFERS OF FINANCIAL ASSETS
Through our MCA business, we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to Ginnie Mae and government sponsored entities ("GSEs") such as Fannie Mae and Freddie Mac. We have elected to carry these loans at fair value based on sales commitments, market quotes or pricing models. Gains and losses on the sale of mortgage loans held for sale and changes in the fair value of the loans held for sale and related derivatives are included in other non-interest income on the consolidated statements of income and other comprehensive income. For the nine months ended September 30, 2018 and 2017, losses totaled $7.8 million and $1.0 million, respectively.
Residential mortgage loans held for sale are subject to both credit and interest rate risk. Credit risk is managed through underwriting policies and procedures, including collateral requirements, which are generally accepted by the secondary loan markets. Exposure to interest rate fluctuations is partially mitigated through forward sales contracts, which set the price for loans that will be delivered in the next 60 to 90 days.
The table below presents the unpaid principal balance of loans held for sale and related fair values at September 30, 2018 and December 31, 2017 (in thousands):
 
September 30, 2018
 
December 31, 2017
Outstanding balance(1)
$
1,658,630

 
$
1,009,271

Fair value(1)
1,651,930

 
1,007,695

Fair value over/(under) outstanding balance
$
(6,700
)
 
$
(1,576
)
(1)
Does not include $3.3 million of Small Business Administration ("SBA") loans held for sale carried at lower of cost or market as of December 31, 2017.
No loans held for sale were on non-accrual as of September 30, 2018 or December 31, 2017. At September 30, 2018 and December 31, 2017, we had $25.2 million and $19.7 million, respectively, in outstanding balances of loans held for sale that were 90 days or more past due. The $25.2 million loans held for sale that were 90 days or more past due at September 30, 2018 included $19.8 million in loans guaranteed by U.S. government agencies that were repurchased out of Ginnie Mae securities and recorded as loans held for sale, at fair value, on the balance sheet. Interest on these past due loans accrues at the debenture rate guaranteed by the U.S. government. Also included in the $25.2 million were $5.0 million in loans that, pursuant to Ginnie Mae servicing guidelines, we have the unilateral right, but not the obligation, to repurchase if defined delinquent loan criteria are met, and therefore must record as loans held for sale on our balance sheet regardless of whether the repurchase option has been exercised. The comparable balances at December 31, 2017 were no loans repurchased and $19.0 million in loans for which we have the unilateral right but not the obligation to repurchase.
The table below presents a reconciliation of the changes in loans held for sale for the nine months ended September 30, 2018 and 2017 (in thousands):
 
Nine months ended September 30,
 
2018
 
2017
Beginning balance
$
1,011,004

 
$
968,929

Loans purchased
5,012,188

 
4,315,065

Payments and loans sold
(4,366,138
)
 
(4,337,919
)
Change in fair value
(5,124
)
 
9,908

Ending balance
$
1,651,930

 
$
955,983



21



We generally retain the right to service the loans sold, creating MSRs which are recorded as assets on our balance sheet. A summary of MSR activity for the nine months ended September 30, 2018 and 2017 is as follows (in thousands):
 
Nine months ended September 30,
 
2018
 
2017
MSRs:
 
 
 
Balance, beginning of year
$
88,150

 
$
28,536

    Capitalized servicing rights
32,871

 
54,614

    Amortization
(7,920
)
 
(5,304
)
    Sales
(26,742
)
 

Balance, end of period
$
86,359

 
$
77,846

Valuation allowance:
 
 
 
Balance, beginning of year
$
2,823

 
$

    Increase (decrease) in valuation allowance
(2,823
)
 
216

Balance, end of period
$

 
$
216

MSRs, net(1)
$
86,359

 
$
77,630

MSRs, fair value
$
98,391

 
$
78,940

(1)
MSRs are reported on the consolidated balance sheets at amortized cost, less a valuation allowance if the fair value of identified strata, determined by interest rates, within the MSR portfolio are determined to have a fair value that is less than amortized cost.
We completed a sale of Ginnie Mae MSRs in the first quarter of 2018. In anticipation of this sale, the fair value of the MSRs at December 31, 2017 was adjusted, resulting in a $2.8 million impairment charge taken in the fourth quarter of 2017 that was subsequently reversed upon completion of the sale in the first quarter of 2018.
At September 30, 2018 and December 31, 2017, our servicing portfolio of residential mortgage loans had an outstanding principal balance of $7.3 billion and $7.0 billion, respectively. In connection with the servicing of these loans, we hold deposits in the names of the investors who own the loans representing escrow funds for taxes and insurance, as well as collections in transit to the investors. These escrow funds are segregated and held in separate non-interest-bearing accounts at the Bank. These deposits, included in total non-interest-bearing deposits on the consolidated balance sheets, were $96.5 million at September 30, 2018 and $73.4 million at December 31, 2017.
The estimated fair value of the MSR assets is obtained from an independent third party and reviewed by management on a quarterly basis. MSRs typically do not trade in an active, open market with readily observable prices; as such, the fair value of MSRs is determined using a discounted cash flow model to calculate the present value of the estimated future net servicing income. The assumptions utilized in the discounted cash flow model are based on market data for comparable assets, where available. Each quarter, management and the independent third party discuss the key assumptions used in the discounted cash flow model and make adjustments as necessary to estimate the fair value of the MSRs. As of September 30, 2018 and December 31, 2017, management used the following assumptions to determine the fair value of MSRs:
 
September 30, 2018
 
December 31, 2017
Average discount rates
9.62
%
 
9.90
%
Expected prepayment speeds
8.31
%
 
9.99
%
Weighted average life, in years
7.9

 
7.0

A sensitivity analysis of changes in the fair value of our MSR portfolio resulting from certain key assumptions is presented in the following table (in thousands):
 
September 30, 2018
 
December 31, 2017
50 bp adverse change in prepayment speed
$
(11,581
)
 
$
(11,896
)
100 bp adverse change in prepayment speed
(24,868
)
 
(28,226
)
These sensitivities are hypothetical and actual results may differ materially due to a number of factors. The effect on fair value of a 10% variation in assumptions generally cannot be determined with confidence because the relationship of the change in

22



assumptions to the fair value may not be linear. Additionally, the impact of a variation in a particular assumption on the fair value is calculated while holding other assumptions constant. In reality, changes in one factor may be correlated with changes in other factors, which could impact the sensitivity analysis as presented.
In conjunction with the sale and securitization of loans held for sale, we may be exposed to liability resulting from recourse agreements and repurchase agreements. If it is determined subsequent to our sale of a loan that the loan sold is in breach of the representations or warranties made in the applicable sale agreement, we may have an obligation to either (a) repurchase the loan for the unpaid principal balance, accrued interest and related advances, (b) indemnify the purchaser against any loss it suffers or (c) make the purchaser whole for the economic benefits of the loan.
Our repurchase, indemnification and make whole obligations vary based upon the terms of the applicable agreements, the nature of the asserted breach and the status of the mortgage loan at the time a claim is made. We establish reserves for estimated losses of this nature inherent in the origination of mortgage loans by estimating the losses inherent in the population of all loans sold based on trends in claims and actual loss severities experienced. The reserve includes accruals for probable contingent losses in addition to those identified in the pipeline of claims received. The estimation process is designed to include amounts based on any actual losses experienced from actual repurchase activity.
Our estimated exposure related to loans previously sold and currently held for sale was $1.6 million at September 30, 2018 and $1.3 million at December 31, 2017 and is recorded in other liabilities in the consolidated balance sheets. We had $187,000 in losses due to repurchase, indemnification and make-whole obligations during the nine months ended September 30, 2018 and $14,000 in losses during the nine months ended September 30, 2017.
(7) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank 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. These financial instruments include commitments to extend credit and standby letters of credit that involve varying degrees of credit risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the borrower.
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 may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
The table below summarizes our off-balance sheet financial instruments whose contract amounts represented credit risk (in thousands): 
 
September 30, 2018
 
December 31, 2017
Commitments to extend credit
$
7,510,397

 
$
6,957,847

Standby letters of credit
235,471

 
230,958

At September 30, 2018 and December 31, 2017, we had $10.3 million and $9.1 million, respectively, in allowance for off-balance sheet credit losses related to these off-balance sheet commitments recorded in other liabilities in the consolidated balance sheets.
(8) REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal 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 adverse effect on the Company’s and the Bank’s 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 the Company’s and the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the

23

Table of Contents

Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
The Basel III regulatory capital framework (the "Basel III Capital Rules") adopted by U.S. federal regulatory authorities, among other things, (i) establishes the capital measure called "Common Equity Tier 1" ("CET1"), (ii) specifies that Tier 1 capital consist of CET1 and "Additional Tier 1 Capital" instruments meeting stated requirements, (iii) requires that most deductions/adjustments to regulatory capital measures be made to CET1 and not to other components of capital and (iv) defines the scope of the deductions/adjustments to the capital measures. The Basel III Capital Rules became effective for us on January 1, 2015 with certain transition provisions fully phasing in over a period ending on January 1, 2019.
Additionally, the Basel III Capital Rules require that we maintain a capital conservation buffer with respect to each of CET1, Tier 1 and total capital to risk-weighted assets, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. The capital conservation buffer is subject to a three year phase-in period that began on January 1, 2016 and will be fully phased in on January 1, 2019 at 2.5%. The required phase-in capital conservation buffer during 2018 is 1.875% and was 1.25% during 2017. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers.
Quantitative measures established by these regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of CET1, Tier 1 and total capital to risk-weighted assets, and of Tier 1 capital to average assets, each as defined in the regulations. Management believes, as of September 30, 2018, that the Company and the Bank met all capital adequacy requirements to which they are subject.
Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier 1 risk-based, CET1 and Tier 1 leverage ratios. As shown in the table below, the Company’s capital ratios exceeded the regulatory definition of adequately capitalized as of September 30, 2018 and December 31, 2017. Based upon the information in its most recently filed call report, the Bank met the capital ratios necessary to be well capitalized. The regulatory authorities can apply changes in classification of assets and such changes may retroactively subject the Company to changes in capital ratios. Any such changes could result in reducing one or more capital ratios below well-capitalized status. In addition, a change may result in imposition of additional assessments by the FDIC or could result in regulatory actions that could have a material adverse effect on our financial condition and results of operations.
Because our Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, we are allowed to continue to classify our trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital.

24

Table of Contents

The table below summarizes our actual and required capital ratios under the Basel III Capital Rules: 
 
 
Actual
 
Minimum Capital Required - Basel III Phase-In Schedule
 
Minimum capital Required - Basel III Fully Phased-In
 
Required to be Considered Well Capitalized
 
 
Capital Amount
Ratio
 
Capital Amount
Ratio
 
Capital Amount
Ratio
 
Capital Amount
Ratio
As of September 30, 2018:
 
 
 
 
 
 
 
 
 
 
 
 
CET1
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
$
2,258,596

8.64
%
 
$
1,667,255

6.38
%
 
$
1,830,712

7.00
%
 
N/A

N/A

    Bank
 
2,266,454

8.67
%
 
1,665,912

6.38
%
 
1,829,237

7.00
%
 
1,698,577

6.50
%
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,999,161

11.47
%
 
2,582,611

9.88
%
 
2,746,067

10.50
%
 
N/A

N/A

    Bank
 
2,848,430

10.90
%
 
2,580,531

9.88
%
 
2,743,856

10.50
%
 
2,613,196

10.00
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,516,895

9.62
%
 
2,059,550

7.88
%
 
2,223,007

8.50
%
 
N/A

N/A

    Bank
 
2,424,753

9.28
%
 
2,057,892

7.88
%
 
2,221,217

8.50
%
 
2,090,557

8.00
%
Tier 1 capital (to average assets)(1)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,516,895

9.70
%
 
1,038,268

4.00
%
 
1,038,268

4.00
%
 
N/A

N/A

    Bank
 
2,424,753

9.35
%
 
1,037,796

4.00
%
 
1,037,796

4.00
%
 
1,297,245

5.00
%
As of December 31, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
CET1
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
$
2,033,830

8.45
%
 
$
1,384,448

5.75
%
 
$
1,685,464

7.00
%
 
N/A

N/A

    Bank
 
1,992,152

8.28
%
 
1,383,475

5.75
%
 
1,684,231

7.00
%
 
1,563,929

6.50
%
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,768,153

11.50
%
 
2,227,221

9.25
%
 
2,528,196

10.50
%
 
N/A

N/A

    Bank
 
2,567,961

10.67
%
 
2,225,591

9.25
%
 
2,526,347

10.50
%
 
2,406,044

10.00
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,293,016

9.52
%
 
1,745,659

7.25
%
 
2,046,635

8.50
%
 
N/A

N/A

    Bank
 
2,151,338

8.94
%
 
1,744,382

7.25
%
 
2,045,138

8.50
%
 
1,924,835

8.00
%
Tier 1 capital (to average assets)(1)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,293,016

9.15
%
 
1,002,494

4.00
%
 
1,002,494

4.00
%
 
N/A

N/A

    Bank
 
2,151,338

8.59
%
 
1,002,144

4.00
%
 
1,002,144

4.00
%
 
1,252,680

5.00
%
(1)
The Tier 1 capital ratio (to average assets) is not impacted by the Basel III Capital Rules; however, it should be noted that the Federal Reserve Board and the FDIC may require the Company and the Bank, respectively, to maintain a Tier 1 capital ratio (to average assets) above the required minimum.
Our mortgage finance loan volumes can increase significantly at month end, causing a meaningful difference between ending balance and average balance for any period. At September 30, 2018, our total mortgage finance loans were $5.5 billion compared to the average for the three months ended September 30, 2018 of $5.4 billion. As CET1, Tier 1 and total capital ratios are calculated using quarter-end risk-weighted assets and our mortgage finance loans are 100% risk-weighted (excluding MCA mortgage loans held for sale, which receive lower risk weights), the quarter-end fluctuation in these balances can significantly impact our reported ratios. Due to the actual risk profile and liquidity of this asset class, we manage capital allocated to mortgage finance loans based on changing trends in average balances and do not believe that the quarter-end balance is representative of risk characteristics that would justify higher allocations. However, we continue to monitor our capital allocation to confirm that all capital levels remain above well-capitalized levels.
Dividends that may be paid by subsidiary banks are routinely restricted by various regulatory authorities. The amount that can be paid in any calendar year without prior approval of the Bank’s regulatory agencies cannot exceed the lesser of the net profits (as defined) for that year plus the net profits for the preceding two calendar years, or retained earnings. The Basel III Capital

25

Table of Contents

Rules further limit the amount of dividends that may be paid by our Bank. No dividends were declared or paid on our common stock during the nine months ended September 30, 2018 or 2017.
(9) STOCK-BASED COMPENSATION
We have long-term incentive plans under which stock-based compensation awards are granted to employees and directors by the board of directors, or its designated committee. Grants are subject to vesting requirements and may include, among other things, nonqualified stock options, stock appreciation rights ("SARs"), restricted stock units ("RSUs"), restricted stock and performance units, or any combination thereof. There are 2,550,000 total shares authorized for grant under the plans.
The table below summarizes our stock-based compensation expense for the three and nine months ended September 30, 2018 and 2017 (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Stock-settled awards:
 
 
 
 
 
 
 
SARs
$
19

 
$
64

 
$
112

 
$
210

RSUs
2,261

 
2,184

 
6,235

 
5,491

Restricted stock
12

 
8

 
36

 
16

Cash-settled performance units
2,144

 
3,811

 
9,250

 
9,304

Total
$
4,436

 
$
6,067

 
$
15,633

 
$
15,021

 
(in thousands)
September 30, 2018
Unrecognized compensation expense related to unvested stock-settled awards
$
17,487

Weighted average period over which expense is expected to be recognized, in years
2.8

(10) INCOME TAXES
The Tax Cuts and Jobs Act (the "Tax Act") enacted in December 2017 reduced the federal corporate income tax rate from 35% to 21% effective January 1, 2018. As a result of the Tax Act, we re-measured certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%. However, we are still analyzing certain aspects of the Tax Act and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded in 2017 related to the re-measurement of our deferred tax asset was $17.6 million, and no further adjustments were made during the nine months ended September 30, 2018.
The reconciliation of our total effective income tax rate to the U.S. federal statutory tax rate for the nine months ended September 30, 2018 and 2017 is as follows:
 
Nine months ended September 30,
 
2018
 
2017
U.S. statutory rate
21
 %
 
35
 %
State taxes
1
 %
 
1
 %
Non-deductible expenses
1
 %
 
 %
Non-taxable income
(1
)%
 
(1
)%
Other
(1
)%
 
(1
)%
Effective tax rate
21
 %
 
34
 %
(11) FAIR VALUE DISCLOSURES
We determine the fair market values of our assets and liabilities measured at fair value on a recurring and nonrecurring basis using the fair value hierarchy as prescribed in ASC 820, Fair Value Measurements and Disclosures. The standard describes three levels of inputs that may be used to measure fair value as provided below.

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Level 1
Quoted prices in active markets for identical assets or liabilities. This category includes the assets and liabilities related to our non-qualified deferred compensation plan where values are based on quoted market prices for identical equity securities in an active market.
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets include agency mortgage-backed debt securities and Community Reinvestment Act funds. This category also includes certain loans held for sale and derivative assets and liabilities where values are obtained from independent pricing services using observable market data.
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies or similar techniques, as well as instruments for which the determination of fair values requires significant management judgment or estimation. This category includes tax-exempt asset-backed securities for which fair value is determined using a price-based model and certain loans held for sale for which fair values are determined using third party pricing models. This category also includes impaired loans and OREO where collateral values have been based on third party appraisals; however, comparative sales data typically used in appraisals may be unavailable or more subjective in certain markets due to lack of market activity.

Assets and liabilities measured at fair value at September 30, 2018 and December 31, 2017 are as follows (in thousands):
 
Fair Value Measurements Using
September 30, 2018
Level 1
 
Level 2
 
Level 3
Available-for-sale debt securities:(1)
 
 
 
 
 
Residential mortgage-backed securities
$

 
$
7,709

 
$

Tax-exempt asset-backed securities

 

 
93,369

Equity securities(1)(2)
9,461

 
6,850

 

Loans held for sale (3)

 
1,630,017

 
21,913

Loans held for investment(4)(6)

 

 
19,823

OREO(5)(6)

 

 
79

Derivative assets(7)

 
35,781

 

Derivative liabilities(7)

 
27,381

 

Non-qualified deferred compensation plan liabilities (8)
10,467

 

 

 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
Available-for-sale debt securities:(1)
 
 
 
 
 
Residential mortgage-backed securities
$

 
$
10,945

 
$

Equity securities(1)(2)
5,460

 
7,106

 

Loans held for sale(3)

 
1,007,695

 

Loans held for investment(4)(6)

 

 
21,216

OREO(5)(6)

 

 
11,742

Derivative assets(7)

 
16,719

 

Derivative liabilities(7)

 
17,377

 

Non-qualified deferred compensation plan liabilities (8)
5,587

 

 

 
(1)
Securities are measured at fair value on a recurring basis, generally monthly, except for tax-exempt asset-backed securities which are measured quarterly.
(2)
Equity securities consist of Community Reinvestment Act funds and investments related to our non-qualified deferred compensation plan.
(3)
Loans held for sale, excluding SBA loans which are carried at lower of cost or market, are measured at fair value on a recurring basis, generally monthly.

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(4)
Includes impaired loans that have been measured for impairment at the fair value of the loan’s collateral.
(5)
OREO is transferred from loans to OREO at fair value less selling costs.
(6)
Loans held for investment and OREO are measured on a nonrecurring basis, generally annually or more often as warranted by market and economic conditions.
(7)
Derivative assets and liabilities are measured at fair value on a recurring basis, generally quarterly.
(8)
Non-qualified deferred compensation plan liabilities represent the fair value of the obligation to the employee, which corresponds to the fair value of the invested assets, and are measured at fair value on a recurring basis, generally monthly.
Level 3 Valuations
Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments include those for which the determination of fair value requires significant management judgment or estimation. Currently, we measure the fair value of tax-exempt asset-backed securities using a price-based model and certain loans held for sale using third party pricing models on a recurring basis, and measure certain collateral dependent impaired loans and OREO on a nonrecurring basis as described below.
Level 3 Fair Value Rollforward
The following table presents a reconciliation for the three and nine months ended September 30, 2018 of the level 3 fair value category measured at fair value on a recurring basis using Level 3 inputs (in thousands):
 
 
 
 
 
 
 
Net Realized/Unrealized Gains (Losses)
 
 
 
Balance at Beginning of Period
 
Purchases / Additions
 
Sales / Reductions
 
Realized
 
Unrealized
 
Balance at End of Period
Three months ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Tax-exempt asset-backed securities(1)
$

 
$
95,521

 
$

 
$

 
$
(2,152
)
 
$
93,369

Loans held for sale(2)
$
27,929

 
$
901

 
$
(6,948
)
 
$
(134
)
 
$
165

 
$
21,913

 
 
 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Tax-exempt asset-backed securities
$

 
$
95,521

 
$

 
$

 
$
(2,152
)
 
$
93,369

Loans held for sale
$

 
$
38,430

 
$
(14,936
)
 
$
(66
)
 
$
(1,515
)
 
$
21,913

(1)
Changes in fair value of available-for-sale debt securities are recorded in accumulated other comprehensive income.
(2)
Recorded in other non-interest income.

Tax-exempt asset-backed securities
The fair value of tax-exempt asset-backed securities is based on a price-based model, which utilizes Level 3, or unobservable, inputs. The fair value of these securities is generally based upon quoted prices of the underlying assets, which are used to calculate a weighted-average value. Other considerations include credit deterioration of underlying bonds, the probability of the sponsor exercising their call option and liquidity risks due to the instrument not being actively traded. At September 30, 2018, the fair value of these securities was calculated using a weighted-average price of 97.7%.
Loans held for sale
The fair value of loans held for sale using Level 3 inputs include loans that cannot be sold through normal sale channels and thus require significant management judgment or estimation when determining the fair value. The fair value of such loans is generally based upon quoted prices of comparable loans with a liquidity discount applied. At September 30, 2018, the fair value of these loans was calculated using a weighted-average discounted price of 93.5%.

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Loans held for investment
At September 30, 2018 and December 31, 2017, certain impaired loans held for investment were reported at fair value through a specific allocation of the allowance for loan losses based upon the fair value of the underlying collateral. The $19.8 million fair value of loans held for investment at September 30, 2018 reported above includes impaired loans held for investment with a carrying value of $28.0 million that were reduced by specific allowance allocations totaling $8.2 million based on collateral valuations utilizing Level 3 inputs. The $21.2 million fair value of loans held for investment at December 31, 2017 reported above includes impaired loans with a carrying value of $32.2 million that were reduced by specific valuation allowance allocations totaling $11.0 million based on collateral valuations utilizing Level 3 inputs. Fair values were based on third party appraisals, which are Level 3 inputs.
OREO
Certain foreclosed assets, upon initial recognition, are recorded at fair value less estimated selling costs. At September 30, 2018 and December 31, 2017, OREO had a carrying value of $79,000 and $11.7 million, respectively, with no valuation allowance at September 30, 2018 or December 31, 2017. The fair value of OREO was computed based on third party appraisals, which are Level 3 inputs.
Fair Value of Financial Instruments
GAAP requires disclosure of fair value information about financial instruments, whether or not recognized on the balance sheet, for which it is practical to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. This disclosure does not and is not intended to represent the fair value of the Company.
A summary of the carrying amounts and estimated fair values of financial instruments is as follows (in thousands):
 
 
September 30, 2018
 
December 31, 2017
  
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial assets:
 
 
 
 
 
 
 
   Level 1 inputs:
 
 
 
 
 
 
 
Cash and cash equivalents
$
2,785,051

 
$
2,785,051

 
$
2,905,591

 
$
2,905,591

Investment securities
9,461

 
9,461

 
5,460

 
5,460

   Level 2 inputs:
 
 
 
 
 
 
 
Investment securities
14,559

 
14,559

 
18,051

 
18,051

Loans held for sale
1,630,017

 
1,630,017

 
1,011,004

 
1,011,004

Derivative assets
35,781

 
35,781

 
16,719

 
16,719

   Level 3 inputs:
 
 
 
 
 
 
 
Investment securities
93,369

 
93,369

 

 

Loans held for sale
21,913

 
21,913

 

 

Loans held for investment, net
21,857,019

 
21,843,389

 
20,489,757

 
20,480,802

Financial liabilities:
 
 
 
 
 
 
 
   Level 2 inputs:
 
 
 
 
 
 
 
Federal funds purchased
475,842

 
475,842

 
359,338

 
359,338

Customer repurchase agreements
10,976

 
10,976

 
5,702

 
5,702

Other borrowings
3,200,000

 
3,200,000

 
2,800,000

 
2,800,000

Subordinated notes
281,677

 
282,247

 
281,406

 
285,485

Derivative liabilities
27,381

 
27,381

 
17,377

 
17,377

   Level 3 inputs:
 
 
 
 
 
 
 
Deposits
20,385,637

 
20,386,435

 
19,123,180

 
19,124,121

Trust preferred subordinated debentures
113,406

 
113,406

 
113,406

 
113,406


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The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Investment Securities
Within the investment securities portfolio, we hold equity securities related to our non-qualified deferred compensation plan that are valued using quoted market prices for identical equity securities in an active market, and are classified as Level 1 assets in the fair value hierarchy. The fair value of the remaining equity securities and residential mortgage-backed securities in our investment portfolio are based on prices obtained from independent pricing services that are based on quoted market prices for the same or similar securities, and are characterized as Level 2 assets in the fair value hierarchy. We have obtained documentation from our primary pricing service regarding their processes and controls applicable to pricing investment securities, and on a quarterly basis we independently verify the prices that we receive from the service provider using two additional independent pricing sources. We also hold tax-exempt asset-backed securities that are valued using a price-based model, which utilizes Level 3 inputs, and are classified as Level 3 assets in the fair value hierarchy.
Loans Held for Sale
Fair value for loans held for sale is derived from quoted market prices for similar loans, in which case they are characterized as Level 2 assets in the fair value hierarchy, or is derived from third party pricing models, in which case they are characterized as Level 3 assets in the fair value hierarchy.
Derivatives
The estimated fair value of interest rate swaps and caps is obtained from independent pricing services based on quoted market prices for similar derivative contracts and these financial instruments are characterized as Level 2 assets and liabilities in the fair value hierarchy. On a quarterly basis, we independently verify the fair value using an additional independent pricing source. Any significant differences are investigated and resolved. Foreign currency forward contracts are valued based upon quoted market prices obtained from independent pricing services for similar derivative contracts. As such, these financial instruments are characterized as Level 2 assets and liabilities in the fair value hierarchy. The derivative instruments related to the loans held for sale portfolio include loan purchase commitments and forward sales commitments. Loan purchase commitments are valued based upon the fair value of the underlying mortgage loans to be purchased, which is based on observable market data for similar loans. Forward sales commitments are valued based upon quoted market prices from brokers. As such, these loan purchase commitments and forward sales commitments are characterized as Level 2 assets or liabilities in the fair value hierarchy.
(12) DERIVATIVE FINANCIAL INSTRUMENTS
The fair value of derivative positions outstanding is included in accrued interest receivable and other assets and other liabilities in the accompanying consolidated balance sheets on a net basis when a right of offset exists, based on transactions with a single counterparty that are subject to a legally enforceable master netting agreement.
We enter into interest rate derivative positions that are not designated as hedging instruments. These derivative positions relate to transactions in which we enter into an interest rate swap, cap and/or floor with a customer while at the same time entering into an offsetting interest rate swap, cap and/or floor with another financial institution. In connection with each swap transaction, we agree 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, we agree 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 transaction allows our customer to effectively convert a variable rate loan to a fixed rate. Because we act 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 our results of operations.
We also enter into foreign currency forward contracts that are not designated as hedging instruments. These derivative instruments relate to transactions in which we enter into a contract with a customer to buy or sell a foreign currency at a future date for a specified price while at the same time entering into an offsetting contract with a financial institution to buy or sell the same currency at the same future date for a specified price. These transactions allow our customers to manage their exposure to foreign currency exchange rate fluctuations. Because we act as an intermediary for our customer, changes in the fair value of the underlying derivative instruments substantially offset each other and do not have a material impact on our results of operations.
We also enter into loan purchase commitment contracts with mortgage originators to purchase residential mortgage loans at a future date, as well as forward sales commitment contracts to sell residential mortgage loans at a future date as part of our MCA program. The objective of these transactions is to mitigate our exposure to interest rate risk associated with the purchase of

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mortgage loans held for sale. Any changes in fair value are recorded in other non-interest expense in the consolidated statements of income and other comprehensive income.
The notional amounts and estimated fair values of interest rate derivative positions outstanding at September 30, 2018 and December 31, 2017 are presented in the following tables (in thousands):
 
 
September 30, 2018
 
December 31, 2017
 
Estimated Fair Value
 
Estimated Fair Value
 
Notional
Amount
 
Asset Derivative
 
Liability Derivative
 
Notional
Amount
 
Asset Derivative
 
Liability Derivative
Non-hedging interest rate derivatives:
 
 
 
 
 
 
 
 
 
 
 
Financial institution counterparties:
 
 
 
 
 
 
 
 
 
 
 
Commercial loan/lease interest rate swaps
$
1,593,483

 
$
21,796

 
$
4,691

 
$
1,393,764

 
$
4,736

 
$
15,482

Commercial loan/lease interest rate caps
567,490

 
2,525

 
17

 
242,700

 
421

 
7

Foreign currency forward contracts
50,975

 
2,441

 

 
2,466

 
4

 
69

Customer counterparties:
 
 
 
 
 
 
 
 
 
 
 
Commercial loan/lease interest rate swaps
1,593,483

 
4,691

 
21,796

 
1,393,764

 
15,482

 
4,736

Commercial loan/lease interest rate caps
567,490

 
17

 
2,525

 
242,700

 
7

 
421

Foreign currency forward contracts
50,975

 

 
2,441

 
2,466

 
69

 
4

Economic hedging interest rate derivatives:
 
 
 
 
 
 
 
 
 
 
 
Loan purchase commitments
308,933

 
1,104

 
81

 
253,815

 
635

 
190

Forward sales commitments
1,851,500

 
7,441

 
64

 
1,086,224

 

 
1,103

Gross derivatives
 
 
40,015

 
31,615

 
 
 
21,354

 
22,012

Offsetting derivative assets/liabilities
 
 
(4,234
)
 
(4,234
)
 
 
 
(4,635
)
 
(4,635
)
Net derivatives included in the consolidated balance sheets
 
 
$
35,781

 
$
27,381

 
 
 
$
16,719

 
$
17,377

The weighted average received and paid interest rates for interest rate swaps outstanding at September 30, 2018 and December 31, 2017 were as follows:
 
 
September 30, 2018
Weighted Average Interest Rate
 
December 31, 2017
Weighted Average Interest Rate
 
Received
 
Paid
 
Received
 
Paid
Non-hedging interest rate swaps
3.92
%
 
4.17
%
 
3.59
%
 
4.34
%
The weighted average strike rate for outstanding interest rate caps was 3.17% at September 30, 2018 and 2.40% at December 31, 2017.
Our credit exposure on derivative instruments is limited to the net favorable value and interest payments by each counterparty. In some cases collateral may be required from the counterparties involved if the net value of the derivative instruments exceeds a nominal amount. Our credit exposure associated with these instruments, net of any collateral pledged, was approximately $20.9 million at September 30, 2018 and approximately $16.7 million at December 31, 2017. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap and cap values, as well as for changes in the value of forward sales commitments. At September 30, 2018, we had pledged to counterparties $740,000 in cash collateral for these derivatives, all of which was included in interest-bearing deposits in other banks, and counterparties had pledged to us $17.9 million in cash collateral included in interest-bearing deposits. At December 31, 2017, we had pledged to counterparties $15.2 million in cash collateral for these derivatives, of which $14.0 million was included in interest-bearing deposits in other banks and $1.2 million was included in accrued interest receivable and other assets.
We also enter into credit risk participation agreements with financial institution counterparties for interest rate swaps related to loans in which we are either a participant or a lead bank. The risk participation agreements entered into by us as a participant

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bank provide credit protection to the financial institution counterparty should the borrower fail to perform on its interest rate derivative contract with that financial institution. We are party to 14 risk participation agreements where we are a participant bank having a notional amount of $133.1 million at September 30, 2018, compared to 15 risk participation agreements having a notional amount of $157.1 million at December 31, 2017. The maximum estimated exposure to these agreements, assuming 100% default by all obligors, was approximately $120,000 at September 30, 2018 and $221,000 at December 31, 2017. The fair value of these exposures was insignificant to the consolidated financial statements at both September 30, 2018 and December 31, 2017. Risk participation agreements entered into by us as the lead bank provide credit protection to us should the borrower fail to perform on its interest rate derivative contract with us. We are party to 10 risk participation agreements where we are the lead bank having a notional amount of $122.4 million at September 30, 2018, compared to 10 agreements having a notional amount of $86.3 million at December 31, 2017.
(13) NEW ACCOUNTING PRONOUNCEMENTS
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" ("ASU 2018-15") 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). ASU 2018-15 will be effective for us on January 1, 2020 and is not expected to have an impact on our consolidated financial statements as we currently apply this guidance in practice.
ASU 2018-13 "Fair Value Measurement (Topic 820) - Changes to the Disclosure Requirements for Fair Value Measurement" ("ASU 2018-13") removes the requirement to disclose the amount of and reasons for transfers between Level 1 and Level 2 fair value measurement methodologies, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. It also adds a requirement to disclose changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 measurements. For certain unobservable inputs, entities may disclose other quantitative information in lieu of the weighted average if the 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 will be effective for us on January 1, 2020. We are evaluating the impact adoption will have on our disclosures.
ASU 2016-13 "Financial Instruments - Credit Losses (Topic 326)" ("ASU 2016-13") requires an entity to utilize a new impairment model known as the current expected credit loss ("CECL") model to estimate its lifetime "expected credit loss" and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in more timely recognition of credit losses. ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities. Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. ASU 2016-13 will be effective for us on January 1, 2020. We are evaluating the impact adoption of ASU 2016-13 will have on our consolidated financial statements and disclosures. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption could be significantly influenced by the composition, characteristics and quality of our loan portfolio as well as the prevailing economic conditions and forecasts as of the adoption date. As part of our evaluation process, we have established a steering committee and working group that includes individuals from various functional areas to assess processes, portfolio segmentation, systems requirements and needed resources to implement this new accounting standard.
ASU 2016-02 "Leases (Topic 842)" ("ASU 2016-02") requires that lessees and lessors recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. ASU 2016-02 will be effective for us on January 1, 2019. ASU 2016-02 provides for a modified retrospective transition approach requiring lessees to recognize and measure leases on the balance sheet at the beginning of either the earliest period presented or as of the beginning of the period of adoption with the option to elect certain practical expedients. We are electing to apply ASU 2016-02 as of the beginning of the period of adoption (January 1, 2019) and will not restate comparative periods. We also expect to elect certain optional practical expedients. We have implemented a third party software solution to assist with the accounting under the new standard.  Our operating leases relate primarily to office space and bank branches. Based on our current lease portfolio, we anticipate recognizing a lease liability and related right-of-use asset on our balance sheet, with an immaterial impact on our income statement compared to the current lease accounting model. However, the ultimate impact of the standard will depend on the company’s lease portfolio as of the adoption date.



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QUARTERLY FINANCIAL SUMMARIES – UNAUDITED
Consolidated Daily Average Balances, Average Yields and Rates
(In thousands)

 
For the three months ended 
 September 30, 2018
 
For the three months ended 
 September 30, 2017
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Investment securities – taxable
$
24,221

 
$
191

 
3.14
%
 
$
86,087

 
$
340

 
1.57
%
Investment securities – non-taxable(2)
91,298

 
1,228

 
5.33
%
 

 

 
%
Federal funds sold and securities purchased under resale agreements
203,972

 
1,018

 
1.98
%
 
205,938

 
642

 
1.24
%
Interest-bearing deposits in other banks
1,697,787

 
8,386

 
1.96
%
 
2,383,060

 
7,544

 
1.26
%
Loans held for sale
1,484,459

 
17,272

 
4.62
%
 
1,009,703

 
9,882

 
3.88
%
Loans held for investment, mortgage finance
5,443,829

 
49,715

 
3.62
%
 
4,847,530

 
42,294

 
3.46
%
Loans held for investment(1)(2)
16,331,622

 
225,604

 
5.48
%
 
14,427,980

 
178,839

 
4.92
%
Less reserve for loan losses
179,227

 

 

 
172,774

 

 

Loans held for investment, net
21,596,224

 
275,319

 
5.06
%
 
19,102,736

 
221,133

 
4.59
%
Total earning assets
25,097,961

 
303,414

 
4.80
%
 
22,787,524

 
239,541

 
4.17
%
Cash and other assets
877,954

 
 
 
 
 
713,778

 
 
 
 
Total assets
$
25,975,915

 
 
 
 
 
$
23,501,302

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
$
3,253,310

 
$
13,642

 
1.66
%
 
$
2,145,324

 
$
4,359

 
0.81
%
Savings deposits
7,820,742

 
29,930

 
1.52
%
 
7,618,843

 
17,152

 
0.89
%
Time deposits
1,778,831

 
8,462

 
1.89
%
 
496,076

 
924

 
0.74
%
Total interest-bearing deposits
12,852,883

 
52,034

 
1.61
%
 
10,260,243

 
22,435

 
0.87
%
Other borrowings
2,275,640

 
12,117

 
2.11
%
 
1,821,837

 
5,726

 
1.25
%
Subordinated notes
281,619

 
4,191

 
5.90
%
 
281,256

 
4,191

 
5.91
%
Trust preferred subordinated debentures
113,406

 
1,237

 
4.33
%
 
113,406

 
930

 
3.25
%
Total interest-bearing liabilities
15,523,548

 
69,579

 
1.78
%
 
12,476,742

 
33,282

 
1.06
%
Demand deposits
7,940,503

 
 
 
 
 
8,764,263

 
 
 
 
Other liabilities
116,302

 
 
 
 
 
116,998

 
 
 
 
Stockholders’ equity
2,395,562

 
 
 
 
 
2,143,299

 
 
 
 
Total liabilities and stockholders’ equity
$
25,975,915

 
 
 
 
 
$
23,501,302

 
 
 
 
Net interest income(2)
 
 
$
233,835

 
 
 
 
 
$
206,259

 
 
Net interest margin
 
 
 
 
3.70
%
 
 
 
 
 
3.59
%
Net interest spread
 
 
 
 
3.02
%
 
 
 
 
 
3.11
%
Loan spread(3)
 
 
 
 
3.93
%
 
 
 
 
 
4.02
%
 
(1)
The loan averages include non-accrual loans and are stated net of unearned income.
(2)
Taxable equivalent rates used where applicable.
(3)
Yield on loans, net of reserves, less funding cost including all deposits and borrowed funds.


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For the nine months ended September 30, 2018
 
For the nine months ended September 30, 2017
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Investment securities – taxable
$
24,198

 
$
590

 
3.26
%
 
$
61,212

 
$
851

 
1.86
%
Investment securities – non-taxable(2)
30,767

 
1,228

 
5.33
%
 
74

 
3

 
4.85
%
Federal funds sold and securities purchased under resale agreements
210,531

 
2,808

 
1.78
%
 
218,777

 
1,606

 
0.98
%
Interest-bearing deposits in other banks
1,830,849

 
23,607

 
1.72
%
 
2,645,145

 
19,935

 
1.01
%
Loans held for sale
1,397,121

 
46,833

 
4.48
%
 
973,016

 
27,652

 
3.80
%
Loans held for investment, mortgage finance
4,818,342

 
134,133

 
3.72
%
 
3,811,298

 
98,798

 
3.47
%
Loans held for investment(1)(2)
15,883,407

 
637,692

 
5.37
%
 
13,714,390

 
485,226

 
4.73
%
Less reserve for loan losses
184,216

 

 

 
171,029

 

 

Loans held for investment, net
20,517,533

 
771,825

 
5.03
%
 
17,354,659

 
584,024

 
4.50
%
Total earning assets
24,010,999

 
846,891

 
4.72
%
 
21,252,883

 
634,071

 
3.99
%
Cash and other assets
828,147

 
 
 
 
 
651,270

 
 
 
 
Total assets
$
24,839,146

 
 
 
 
 
$
21,904,153

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
$
2,980,386

 
$
32,587

 
1.46
%
 
$
2,054,701

 
$
9,445

 
0.61
%
Savings deposits
7,862,053

 
77,342

 
1.32
%
 
7,189,274

 
40,575

 
0.75
%
Time deposits
1,092,975

 
13,414

 
1.64
%
 
460,046

 
2,241

 
0.65
%
Total interest-bearing deposits
11,935,414

 
123,343

 
1.38
%
 
9,704,021

 
52,261

 
0.72
%
Other borrowings
2,039,010

 
28,915

 
1.90
%
 
1,539,208

 
11,626

 
1.01
%
Subordinated notes
281,528

 
12,573

 
5.97
%
 
281,167

 
12,573

 
5.98
%
Trust preferred subordinated debentures
113,406

 
3,457

 
4.08
%
 
113,406

 
2,641

 
3.11
%
Total interest-bearing liabilities
14,369,358

 
168,288

 
1.57
%
 
11,637,802

 
79,101

 
0.91
%
Demand deposits
8,034,509

 
 
 
 
 
8,062,792

 
 
 
 
Other liabilities
109,044

 
 
 
 
 
112,505

 
 
 
 
Stockholders’ equity
2,326,235

 
 
 
 
 
2,091,054

 
 
 
 
Total liabilities and stockholders’ equity
$
24,839,146

 
 
 
 
 
$
21,904,153

 
 
 
 
Net interest income(2)
 
 
$
678,603

 
 
 
 
 
$
554,970

 
 
Net interest margin
 
 
 
 
3.78
%
 
 
 
 
 
3.49
%
Net interest spread
 
 
 
 
3.15
%
 
 
 
 
 
3.08
%
Loan spread(3)
 
 
 
 
4.07
%
 
 
 
 
 
4.02
%

(1)
The loan averages include non-accrual loans and are stated net of unearned income.
(2)
Taxable equivalent rates used where applicable.
(3)
Yield on loans, net of reserves, less funding cost including all deposits and borrowed funds.

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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Certain statements and financial analysis contained in this report that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of federal securities laws. Forward-looking statements may also be contained in our future filings with SEC, in press releases and in oral and written statements made by us or with our approval that are not statements of historical fact. These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. Words such as “believes,” “expects,” “estimates,” “anticipates,” “plans,” “goals,” “objectives,” “expects,” “intends,” “seeks,” “likely,” “targeted,” “continue,” “remain,” “will,” “should,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements may include, among other things, statements about the credit quality of our loan portfolio, economic conditions, including the continued impact on our customers from volatility in oil and gas prices, expectations regarding rates of default or loan losses, volatility in the mortgage industry, our business strategies and our expectations about future financial performance, future growth and earnings, the appropriateness of our allowance for loan losses and provision for credit losses, the impact of increased regulatory requirements on our business, increased competition, interest rate risk, new lines of business, new product or service offerings and new technologies.
Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management’s expectations and assumptions at the time the statements are made and are not guarantees of future results. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, the following:
Deterioration of the credit quality of our loan portfolio or declines in the value of collateral related to external factors such as commodity prices, real estate values or interest rates, increased default rates and loan losses or adverse changes in the industry concentrations of our loan portfolio.
Changing economic conditions or other developments adversely affecting our commercial, entrepreneurial and professional customers.
Changes in the value of commercial and residential real estate securing our loans or in the demand for credit to support the purchase and ownership of such assets.
Adverse economic conditions and other factors affecting our middle market customers and their ability to continue to meet their loan obligations.
Unanticipated effects from the Tax Act may limit its benefits or adversely impact our business, which could include decreased demand for borrowing by our middle market customers or increased price competition that offsets the benefits of decreased federal income tax expense.
The failure to correctly assess and model the assumptions supporting our allowance for loan losses, causing it to become inadequate in the event of deteriorations in loan quality and increases in charge-offs.
Changes in the U.S. economy in general or the Texas economy specifically resulting in deterioration of credit quality, increases in non-performing assets or charge-offs or reduced demand for credit or other financial services we offer, including the effects from declines in the level of drilling and production related to the continued volatility in oil and gas prices.
Adverse changes in economic or market conditions, in Texas, the United States or internationally, that could affect the credit quality of our loan portfolio or our operating performance.
Unexpected market conditions or regulatory changes that could cause access to capital market transactions and other sources of funding to become more difficult to obtain on terms and conditions that are acceptable to us.
The inadequacy of our available funds to meet our deposit, debt and other obligations as they become due, or our failure to maintain our capital ratios as a result of adverse changes in our operating performance or financial condition, or changes in applicable regulations or regulator interpretation of regulations impacting our business or the characterization or risk weight of our assets.
The failure to effectively balance our funding sources with cash demands by depositors and borrowers.
The failure to manage information systems risk or to prevent cyber-attacks against us, our customers or our third party vendors, or to manage risks from disruptions or security breaches affecting us, our customers or our third party vendors.

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The failure to effectively manage our interest rate risk resulting from unexpectedly large or sudden changes in interest rates or rate or maturity imbalances in our assets and liabilities, and potential adverse effects to our borrowers including their inability to repay loans with increased interest rates.
Legislative and regulatory changes imposing further restrictions and costs on our business, a failure to remain well capitalized or well managed status or regulatory enforcement actions against us, and uncertainty related to future implementation and enforcement of regulatory requirements resulting from the current political environment.
The failure to successfully execute our business strategy, which may include expanding into new markets, developing and launching new lines of business or new products and services within the expected timeframes and budgets or to successfully manage the risks related to the development and implementation of these new businesses, products or services.
The failure to attract and retain key personnel or the loss of key individuals or groups of employees.
Increased or more effective competition from banks and other financial service providers in our markets.
Structural changes in the markets for origination, sale and servicing of residential mortgages.
Uncertainty in the pricing of mortgage loans that we purchase, and later sell or securitize, as well as competition for the MSRs related to these loans and related interest rate risk or price risk resulting from retaining MSRs, and the potential effects of higher interest rates on our MCA loan volumes.
Material failures of our accounting estimates and risk management processes based on management judgment, or the supporting analytical and forecasting models.
Failure of our risk management strategies and procedures, including failure or circumvention of our controls.
Credit risk resulting from our exposure to counterparties.
An increase in the incidence or severity of fraud, illegal payments, security breaches and other illegal acts impacting our Bank and our customers.
The failure to maintain adequate regulatory capital to support our business.
Unavailability of funds obtained from borrowing or capital transactions or from our Bank to fund our obligations.
Incurrence of material costs and liabilities associated with legal and regulatory proceedings and related matters with respect to the financial services industry, including those directly involving us or our Bank.
Environmental liability associated with properties related to our lending activities.
Severe weather, natural disasters, acts of war or terrorism and other external events.
Actual outcomes and results may differ materially from what is expressed in our forward-looking statements and from our historical financial results due to the factors discussed elsewhere in this report or disclosed in our other SEC filings. Forward-looking statements included herein speak only as of the date hereof and should not be relied upon as representing our expectations or beliefs as of any date subsequent to the date of this report. Except as required by law, we undertake no obligation to revise any forward-looking statements contained in this report, whether as a result of new information, future events or otherwise. The factors discussed herein are not intended to be a complete summary of all risks and uncertainties that may affect our businesses. For a more detailed discussion of these and other factors that may affect our business, see "Risk Factors" in the 2017 Form 10-K and other filings we have made with the SEC. Though we strive to monitor and mitigate risk, we cannot anticipate all potential economic, operational and financial developments that may adversely impact our operations and our financial results. Forward-looking statements should not be viewed as predictions and should not be the primary basis upon which investors evaluate an investment in our securities.
Overview of Our Business Operations
We commenced our banking operations in December 1998. An important aspect of our growth strategy has been our ability to service and manage effectively a large number of loans and deposit accounts in multiple markets in Texas, as well as several lines of business serving a regional or national clientele of commercial borrowers. Accordingly, we have created an operations infrastructure sufficient to support our lending and banking operations that we continue to build out as needed to serve a larger customer base and specialized industries.
The following discussion and analysis presents the significant factors affecting our financial condition as of September 30, 2018 and December 31, 2017 and results of operations for the three and nine month periods ended September 30, 2018 and

36



2017. This discussion should be read in conjunction with our consolidated financial statements and notes to the financial statements appearing in Part I, Item 1 of this report.
Results of Operations
Summary of Performance
We reported net income of $85.6 million and net income available to common stockholders of $83.1 million, or $1.65 per diluted common share, for the third quarter of 2018 compared to net income of $58.7 million and net income available to common stockholders of $56.2 million, or $1.12 per diluted common share, for the third quarter of 2017. Return on average common equity (“ROE”) was 14.68% and return on average assets ("ROA") was 1.31% for the third quarter of 2018, compared to 11.20% and 0.99%, respectively, for the third quarter of 2017. The improved results for the quarter resulted primarily from an increase in net interest income, as well as a decrease in the provision for credit losses and decrease in income tax expense caused by a decrease in income tax rates as a result of the Tax Cuts and Jobs Act (the "Tax Act") which became effective on January 1, 2018, offset by an increase in non-interest expense.
Net income and net income available to common stockholders for the nine months ended September 30, 2018 totaled $228.9 million and $221.6 million, respectively, or $4.41 per diluted common share, compared to net income and net income available to common stockholders of $152.3 million and $145.0 million, respectively, or $2.89 per diluted common share, for the same period in 2017. ROE was 13.62% and ROA was 1.23% for the nine months ended September 30, 2018 compared to 9.99% and 0.93%, respectively, for the same period in 2017. The improved results for the first nine months of 2018 resulted primarily from an increase in net interest income and a decrease in income tax expense caused by a decline in income tax rates as a result of the Tax Act, offset by increases in the provision for credit losses and non-interest expense.
Details of the changes in the various components of net income are discussed below.

Net Interest Income
Net interest income was $232.2 million for the third quarter of 2018, compared to $204.4 million for the third quarter of 2017. The increase was due to an increase in average earning assets of $2.3 billion as compared to the third quarter of 2017, as well as the effect of increases in interest rates on loan yields. The increase in average earning assets included a $474.8 million increase in average loans held for sale, a $2.5 billion increase in average net loans held for investment and a $29.4 million increase in average investment securities, offset by a $687.2 million decrease in average liquidity assets. For the quarter ended September 30, 2018, average net loans held for investment, liquidity assets and loans held for sale represented approximately 86%, 8% and 6%, respectively, of average earning assets compared to approximately 85%, 11% and 4% for the same quarter of 2017.
Average interest-bearing liabilities for the quarter ended September 30, 2018 increased $3.0 billion from the third quarter of 2017, which included a $2.6 billion increase in average interest-bearing deposits and a $453.8 million increase in other borrowings. Average demand deposits were $7.9 billion for the quarter ended September 30, 2018, compared to $8.8 billion for the same period of 2017. The average cost of total deposits and borrowed funds increased to 1.10% for the third quarter of 2018 compared to 0.54% for the same period of 2017. The cost of interest-bearing liabilities increased from 1.06% for the quarter ended September 30, 2017 to 1.78% for the same period of 2018. The decrease in demand deposits and the increases in deposit and funding costs reflect the impact of the rising interest rate environment and the shift to interest-bearing deposits.

Net interest income was $674.2 million for the nine months ended September 30, 2018, compared to $550.7 million for the same period of 2017. The increase was due to an increase in average earning assets of $2.8 billion as compared to the nine months ended September 30, 2017, as well as the effect of increases in interest rates on loan yields. The increase in average earning assets included a $424.1 million increase in average loans held for sale and a $3.2 billion increase in average net loans held for investment, offset by a $6.3 million decrease in average securities and an $822.5 million decrease in average liquidity assets. For the nine months ended September 30, 2018, average net loans held for investment, liquidity assets and loans held for sale represented approximately 85%, 9% and 6%, respectively, of average earning assets compared to approximately 82%, 13% and 5% for the same period of 2017.
Average interest-bearing liabilities for the nine months ended September 30, 2018 increased $2.7 billion from the same period of 2017, which included a $2.2 billion increase in average interest-bearing deposits and a $499.8 million increase in other borrowings. Average demand deposits decreased from $8.1 billion for the nine months ended September 30, 2017 to $8.0 billion for the nine months ended September 30, 2018. The average cost of total deposits and borrowed funds increased to 0.92% for the nine months ended September 30, 2018 compared to 0.44% for the same period of 2017. The cost of interest-bearing liabilities increased from 0.91% for the nine months ended September 30, 2017 to 1.57% for the same period of 2018.

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The decrease in demand deposits and the increases in deposit and funding costs reflect the impact of the rising interest rate environment and the shift to interest-bearing deposits.
The following table (in thousands) presents changes in taxable-equivalent net interest income between the three and nine month periods ended September 30, 2018 and 2017 and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and changes due to differences in the average interest rate on those assets and liabilities.
 
Three months ended
September 30, 2018/2017
 
Nine months ended
September 30, 2018/2017
 
Net
 
Change Due To(1)
 
Net
 
Change Due To(1)
 
Change
 
Volume
 
Yield/Rate(2)
 
Change
 
Volume
 
Yield/Rate(2)
Interest income:
 
 
 
 
 
 
 
 
 
 
 
Investment securities
$
1,079

 
$
116

 
$
963

 
$
964

 
$
(121
)
 
$
1,085

Loans held for sale
7,390

 
4,643

 
2,747

 
19,181

 
12,281

 
6,900

Loans held for investment, mortgage finance loans
7,421

 
5,200

 
2,221

 
35,335

 
26,026

 
9,309

Loans held for investment
46,765

 
23,607

 
23,158

 
152,466

 
76,387

 
76,079

Federal funds sold and securities purchased under resale agreements
376

 
(6
)
 
382

 
1,202

 
(54
)
 
1,256

Interest-bearing deposits in other banks
842

 
(2,176
)
 
3,018

 
3,672

 
(6,116
)
 
9,788

Total
63,873

 
31,384

 
32,489

 
212,820

 
108,403

 
104,417

Interest expense:
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
9,283

 
2,262

 
7,021

 
23,142

 
4,387

 
18,755

Savings deposits
12,778

 
453

 
12,325

 
36,767

 
3,503

 
33,264

Time deposits
7,538

 
2,393

 
5,145

 
11,173

 
3,317

 
7,856

Other borrowings
6,391

 
1,430

 
4,961

 
17,289

 
3,728

 
13,561

Long-term debt
307

 
5

 
302

 
816

 
15

 
801

Total
36,297

 
6,543

 
29,754

 
89,187

 
14,950

 
74,237

Net interest income
$
27,576

 
$
24,841

 
$
2,735

 
$
123,633

 
$
93,453

 
$
30,180

 
(1)
Yield/rate and volume variances are allocated to yield/rate.
(2)
Taxable equivalent rates are used where applicable.
Net interest margin, which is defined as the ratio of net interest income to average earning assets, was 3.70% for the third quarter of 2018 compared to 3.59% for the third quarter of 2017. The year-over-year increase was due primarily to the increase in total average loans, improved asset composition and the effect of increases in interest rates on loan yields attributable to our asset-sensitive balance sheet. The yield on total loans held for investment increased to 5.06% for the third quarter of 2018 compared to 4.59% for the third quarter of 2017 and the yield on earning assets increased to 4.80% for the third quarter of 2018 compared to 4.17% for the third quarter of 2017. Funding costs, including demand deposits and borrowed funds, increased to 1.10% for the third quarter of 2018 compared to 0.54% for the third quarter of 2017. The spread on total earning assets, net of the cost of deposits and borrowed funds, was 3.70% for the third quarter of 2018 compared to 3.63% for the third quarter of 2017. The increase resulted primarily from increases in interest rates and increases in the higher yielding loan components of earning assets. Total funding costs, including all deposits, long-term debt and stockholders’ equity, increased to 1.07% for the third quarter of 2018 compared to 0.56% for the third quarter of 2017.

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Non-interest Income
The components of non-interest income were as follows (in thousands): 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Service charges on deposit accounts
$
3,477

 
$
3,211

 
$
9,619

 
$
9,323

Wealth management and trust fee income
2,065

 
1,627

 
5,996

 
4,386

Bank owned life insurance (BOLI) income
643

 
615

 
1,959

 
1,562

Brokered loan fees
6,141

 
6,152

 
17,124

 
17,639

Servicing income
4,987

 
4,486

 
15,446

 
10,387

Swap fees
1,355

 
647

 
4,269

 
3,404

Other
6,850

 
2,265

 
8,331

 
8,181

Total non-interest income
$
25,518

 
$
19,003

 
$
62,744

 
$
54,882

Non-interest income increased $6.5 million during the three months ended September 30, 2018 compared to the same period of 2017. This increase was primarily due to a $4.6 million increase in other non-interest income attributable to an increase in gain on sale of MCA loans, as well as a $2.0 million gain on sale of OREO during the three months ended September 30, 2018 resulting from the sale of our largest OREO property.

Non-interest income increased $7.9 million during the nine months ended September 30, 2018 compared to the same period of 2017. This increase was primarily due to a $5.1 million increase in servicing income attributable to an increase in MSRs as well as a $1.6 million increase in wealth management and trust fee income due to an increase in assets under management.
While management expects continued growth in certain components of non-interest income, the future rate of growth could be affected by increased competition from nationwide and regional financial institutions among other factors. In order to achieve growth in non-interest income, management from time to time evaluates new products, new lines of business and the expansion of existing lines of business. Any new product introduction or new market entry could place additional demands on capital and managerial resources.
Non-interest Expense
The components of non-interest expense were as follows (in thousands): 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Salaries and employee benefits
$
77,327

 
$
67,882

 
$
222,268

 
$
194,039

Net occupancy expense
8,362

 
6,436

 
22,952

 
19,062

Marketing
10,214

 
7,242

 
29,127

 
18,349

Legal and professional
10,764

 
6,395

 
29,948

 
20,975

Communications and technology
7,435

 
6,002

 
21,211

 
24,414

FDIC insurance assessment
6,524

 
6,203

 
18,884

 
16,800

Servicing related expenses
4,207

 
3,897

 
12,379

 
8,329

Allowance and other carrying costs for OREO
(1,864
)
 
105

 
467

 
315

Other(1)
13,174

 
10,668

 
37,998

 
30,455

Total non-interest expense
$
136,143

 
$
114,830

 
$
395,234

 
$
332,738

 
(1)
Other expense includes such items as courier expenses, regulatory assessments other than FDIC insurance, due from bank charges and other general operating expenses, none of which account for 1% or more of total interest income and non-interest income.
Non-interest expense for the third quarter of 2018 increased $21.3 million, or 19%, to $136.1 million from $114.8 million in the third quarter of 2017. The increase is primarily due to increases in salaries and employee benefits, net occupancy, marketing, legal and professional, communications and technology and other non-interest expenses, all of which were attributable to general business growth. Offsetting these increases was a $2.0 million decrease in allowance and other carrying

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costs for OREO expense related to the above-mentioned sale of OREO. As a result of the sale, we reversed a $2.0 million valuation allowance that was recorded on the property during the first quarter of 2018.
Non-interest expense for the nine months ended September 30, 2018 increased $62.5 million, or 19%, to $395.2 million from $332.7 million for the nine months ended September 30, 2017. The increase is primarily due to increases in salaries and employee benefits, net occupancy expense, marketing, legal and professional, FDIC insurance assessment and other non-interest expenses, all of which were attributable to general business growth. Servicing related expenses for the nine months ended September 30, 2018 increased $4.1 million compared to the nine months ended September 30, 2017 primarily due to an increase in MSRs, which are being amortized. Offsetting these increases was a $3.2 million decrease in communications and technology expense primarily related to a technology write-off taken in the second quarter of 2017.
Analysis of Financial Condition
Loans Held for Investment
Loans were as follows as of the dates indicated (in thousands):
 
September 30,
2018
 
December 31,
2017
Commercial
$
10,116,945

 
$
9,189,811

Mortgage finance
5,477,787

 
5,308,160

Construction
2,263,463

 
2,166,208

Real estate
3,924,682

 
3,794,577

Consumer
51,692

 
48,684

Leases
319,411

 
264,903

Gross loans held for investment
22,153,980

 
20,772,343

Deferred income (net of direct origination costs)
(106,655
)
 
(97,931
)
Allowance for loan losses
(190,306
)
 
(184,655
)
Total loans held for investment, net
$
21,857,019

 
$
20,489,757

Our business plan focuses primarily on lending to middle market businesses and successful professionals and entrepreneurs, and as such, commercial, real estate and construction loans have comprised a majority of our loan portfolio. Consumer loans generally have represented 1% or less of the portfolio. Mortgage finance loans relate to our mortgage warehouse lending operations in which we purchase mortgage loan ownership interests that are typically sold within 10 to 20 days. Volumes fluctuate based on the level of market demand for the product and the number of days between purchase and sale of the loans, as well as overall market interest rates and tend to peak at the end of each month.
We originate a substantial majority of all loans held for investment, excluding mortgage finance loans. We also participate in syndicated loan relationships, both as a participant and as an agent. As of September 30, 2018, we had $2.1 billion in syndicated loans, $502.3 million of which we administer as agent. All syndicated loans, whether we act as agent or participant, are underwritten to the same standards as all other loans we originate. As of September 30, 2018, $35.0 million of our syndicated loans were on non-accrual.
Portfolio Geographic Concentration
More than 50% of our loan exposure is outside of Texas and more than 50% of our deposits are sourced outside of Texas. However, as of September 30, 2018, a majority of our loans held for investment, excluding our mortgage finance loans and other national lines of business, were to businesses with headquarters and operations in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. We also make loans to these customers that are secured by assets located outside of Texas. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for loan losses.

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Table of Contents

Summary of Loan Loss Experience
The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the allowance for loan losses at a level consistent with management’s assessment of the collectability of the loan portfolio in light of current economic conditions and market trends. We recorded a provision for credit losses of $13.0 million during the third quarter of 2018 compared to $20.0 million in the third quarter of 2017. The decrease in provision recorded during the third quarter of 2018 compared to the same period in 2017 was primarily related to improvements in the composition of our classified loan portfolios, including energy loans.
The allowance for credit losses, including the allowance for losses on unfunded commitments reported on the consolidated balance sheet in other liabilities, totaled $200.6 million at September 30, 2018, $193.7 million at December 31, 2017 and $192.7 million at September 30, 2017. The combined allowance as a percentage of loans held for investment excluding mortgage finance loans decreased to 1.21% at September 30, 2018 from 1.26% at December 31, 2017 and 1.30% at September 30, 2017 as a result of strong loan growth and overall positive trends in the credit quality of our portfolio.
The allowance for credit losses results from consistent application of our loan loss reserve methodology. At September 30, 2018, we believe the allowance is appropriate and has been derived from consistent application of our methodology. Should any of the factors considered by management in evaluating the appropriateness of the allowance for loan losses change, our estimate of inherent losses in the portfolio could also change, which would affect the level of future provisions for loan losses.

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Activity in the allowance for loan losses is presented in the following table (in thousands, except percentage and multiple data):
 
Nine months ended 
 September 30, 2018
 
Year ended
December 31,
2017
 
Nine months ended 
 September 30, 2017
Allowance for loan losses:
 
 
 
 
 
Beginning balance
$
184,655

 
$
168,126

 
$
168,126

Loans charged-off:
 
 
 
 
 
Commercial
45,273

 
34,145

 
32,146

Construction

 
59

 
59

Real estate

 
290

 
290

Consumer
767

 
180

 
180

Leases
319

 

 

Total charge-offs
46,359

 
34,674

 
32,675

Recoveries:
 
 
 
 
 
Commercial
1,069

 
4,593

 
3,574

Construction

 
104

 
104

Real estate
43

 
75

 
74

Consumer
78

 
70

 
56

Leases
32

 
10

 
9

Total recoveries
1,222

 
4,852

 
3,817

Net charge-offs
45,137

 
29,822

 
28,858

Provision for loan losses
50,788

 
46,351

 
43,661

Ending balance
$
190,306

 
$
184,655

 
$
182,929

Allowance for off-balance sheet credit losses:
 
 
 
 
 
Beginning balance
$
9,071

 
$
11,422

 
$
11,422

Provision for off-balance sheet credit losses
1,212

 
(2,351
)
 
(1,661
)
Ending balance
$
10,283

 
$
9,071

 
$
9,761

Total allowance for credit losses
$
200,589

 
$
193,726

 
$
192,690

Total provision for credit losses
$
52,000

 
$
44,000

 
$
42,000

Allowance for loan losses to LHI
0.86
%
 
0.89
%
 
0.89
%
Allowance for loan losses to LHI excluding mortgage finance loans(2)
1.15
%
 
1.20
%
 
1.23
%
Net charge-offs to average LHI(1)
0.29
%
 
0.16
%
 
0.22
%
Net charge-offs to average LHI excluding mortgage finance loans(1)(2)
0.38
%
 
0.21
%
 
0.28
%
Total provision for credit losses to average LHI(1)
0.34
%
 
0.24
%
 
0.32
%
Total provision for credit losses to average LHI excluding mortgage finance loans(1)(2)
0.44
%
 
0.31
%
 
0.41
%
Recoveries to total charge-offs
2.64
%
 
13.99
%
 
11.68
%
Allowance for off-balance sheet credit losses to off-balance sheet credit commitments
0.13
%
 
0.13
%
 
0.14
%
Total allowance for credit losses to LHI
0.91
%
 
0.94
%
 
0.94
%
Total allowance for credit losses to LHI excluding mortgage finance loans(2)
1.21
%
 
1.26
%
 
1.30
%
Allowance for loan losses to non-accrual loans
1.8x

 
1.8x

 
1.5x

 
(1)
Interim period ratios are annualized.
(2)
The indicated ratios are presented with and excluding the mortgage finance loans because the risk profile of our mortgage finance loans is different than our other loans held for investment. No provision for credit losses is allocated to these loans based on the internal risk grade assigned.

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Non-performing Assets
Non-performing assets include non-accrual loans and leases and repossessed assets. The table below summarizes our non-accrual loans by type and by type of property securing the credit and OREO (in thousands): 
 
September 30,
2018
 
December 31,
2017
 
September 30,
2017
 
 
 
 
 
 
Non-accrual loans:(1)
 
 
 
 
 
Commercial
 
 
 
 
 
     Oil and gas properties
$
31,235

 
$
64,192

 
$
80,142

     Assets of the borrowers
41,067

 
7,571

 
9,841

     Inventory
30,182

 
24,399

 
23,121

    Other
2,473

 
3,569

 
3,283

Total commercial
104,957

 
99,731

 
116,387

Real estate
 
 
 
 
 
     Commercial property
1,015

 
1,096

 
1,123

     Unimproved land and/or developed residential lots

 

 

     Single family residences
1,263

 

 

     Other
237

 
617

 
695

Total real estate
2,515

 
1,713

 
1,818

Consumer
60

 

 

Leases

 

 

Total non-accrual loans
107,532

 
101,444

 
118,205

Repossessed assets:
 
 
 
 
 
OREO
79

 
11,742

 
18,131

Other repossessed assets

 

 

Total non-performing assets
$
107,611

 
$
113,186

 
$
136,336

Loans held for investment past due 90 days and accruing(2)
$
11,295

 
$
8,429

 
$
8,892

 
 
 
 
 
 
Loans held for sale past due 90 days and accruing(3)
$
25,238

 
$
19,737

 
$


(1)
As of September 30, 2018December 31, 2017 and September 30, 2017, non-accrual loans included $22.5 million, $18.8 million and $12.0 million, respectively, in loans that met the criteria for restructured.
(2)
At September 30, 2018December 31, 2017 and September 30, 2017, loans past due 90 days and still accruing include premium finance loans of $8.2 million, $5.5 million and $8.4 million, respectively.
(3)
Includes loans guaranteed by U.S. government agencies that were repurchased out of Ginnie Mae securities. Loans are recorded as loans held for sale and carried at fair value on the balance sheet. Interest on these past due loans accrues at the debenture rate guaranteed by the U.S. government. Also includes loans that, pursuant to Ginnie Mae servicing guidelines, we have the unilateral right, but not the obligation, to repurchase if defined delinquent loan criteria are met and therefore must record as loans held for sale on our balance sheet regardless of whether the repurchase option has been exercised.
Potential problem loans consist of loans that are performing in accordance with contractual terms but for which we have concerns about the borrower’s ability to comply with repayment terms because of the borrower’s potential financial difficulties. We monitor these loans closely and review their performance on a regular basis. At September 30, 2018, we had $39.3 million in loans of this type, compared to $49.1 million at December 31, 2017, which were not included in either non-accrual or 90 days past due categories.

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Table of Contents

Loans Held for Sale
Through our MCA program, we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to Ginnie Mae and GSEs such as Fannie Mae and Freddie Mac. For additional information on our loans held for sale portfolio, see Note 6 - Certain Transfers of Financial Assets in the accompanying notes to the consolidated financial statements included elsewhere in this report.


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Table of Contents

Liquidity and Capital Resources
In general terms, liquidity is a measurement of our ability to meet our cash needs. Our objective in managing our liquidity is to maintain our ability to meet loan commitments, purchase investment securities or repay deposits and other liabilities in accordance with their terms, without an adverse impact on our current or future earnings. Our liquidity strategy is guided by policies, formulated and monitored by our senior management and our Balance Sheet Management Committee (“BSMC”), which take into account the demonstrated marketability of assets, the sources and stability of our funding and the level of unfunded commitments. We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost effectiveness. For the year ended December 31, 2017 and for the nine months ended September 30, 2018 our principal source of funding has been our customer deposits, supplemented by our short-term and long-term borrowings, primarily from Federal funds purchased and Federal Home Loan Bank ("FHLB") borrowings, which are generally used to fund mortgage finance assets.
Liquidity assets were $2.6 billion at September 30, 2018, and continue to be significant as a result of deposit growth and increases in borrowing capacity related to our mortgage finance loans. The following table summarizes the composition of liquidity assets (in thousands):
 
September 30,
2018
 
December 31,
2017
 
September 30,
2017
Federal funds sold and securities purchased under resale agreements
$
30,000

 
$
30,000

 
$
25,000

Interest-bearing deposits in other banks
2,585,570

 
2,697,581

 
2,332,537

Total liquidity assets
$
2,615,570

 
$
2,727,581

 
$
2,357,537

 
 
 
 
 
 
Total liquidity assets as a percent of:
 
 
 
 
 
Total loans held for investment, excluding mortgage finance loans
15.8
%
 
17.8
%
 
15.9
%
Total loans held for investment
11.9
%
 
13.2
%
 
11.5
%
Total earning assets
10.0
%
 
11.2
%
 
10.0
%
Total deposits
12.8
%
 
14.3
%
 
12.4
%
Our liquidity needs to support growth in loans held for investment have been fulfilled primarily through growth in our core customer deposits. Our goal is to obtain as much of our funding for loans held for investment and other earning assets as possible from deposits of these core customers. These deposits are generated principally through development of long-term relationships with customers, with a significant focus on treasury management products. In addition to deposits from our core customers, we also have access to deposits through brokered customer relationships. For regulatory purposes, these relationship brokered deposits are categorized as brokered deposits; however, since these deposits arise from a customer relationship, which involves extensive treasury services, we consider these deposits to be core deposits for our reporting purposes.

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We also have access to incremental deposits through brokered retail certificates of deposit, or CDs. These traditional brokered deposits are generally of short maturities, 30 to 90 days, and are used to fund temporary differences in the growth in loan balances, including growth in loans held for sale or other specific categories of loans as compared to customer deposits. The following table summarizes our period-end and average year-to-date core customer deposits, relationship brokered deposits and traditional brokered deposits (in millions):
 
September 30,
2018
 
December 31,
2017
 
September 30,
2017
Deposits from core customers
$
17,044.4

 
$
17,100.8

 
$
17,259.2

Deposits from core customers as a percent of total deposits
83.6
%
 
89.4
%
 
90.5
%
Relationship brokered deposits
$
1,813.0

 
$
2,022.4

 
$
1,822.1

Relationship brokered deposits as a percent of total deposits
8.9
%
 
10.6
%
 
9.5
%
Traditional brokered deposits
$
1,528.2

 
$

 
$

Traditional brokered deposits as a percent of total deposits
7.5
%
 
%
 
%
Average deposits from core customers(1)
$
17,477.8

 
$
16,806.9

 
$
16,239.7

Average deposits from core customers as a percent of total quarterly average deposits(1)
87.5
%
 
91.1
%
 
91.4
%
Average relationship brokered deposits(1)
$
1,878.6

 
$
1,647.0

 
$
1,527.1

Average relationship brokered deposits as a percent of total quarterly average deposits(1)
9.4
%
 
8.9
%
 
8.6
%
Average traditional brokered deposits(1)
$
613.5

 
$

 
$

Average traditional brokered deposits as a percent of total quarterly average deposits(1)
3.1
%
 
%
 
%
(1)
Annual averages presented for December 31, 2017.
We have access to sources of traditional brokered deposits that we estimate to be $4.0 billion. Based on our internal guidelines, we have chosen to limit our use of these sources to a lesser amount. Customer deposits (total deposits, including relationship brokered deposits, minus brokered CDs) at September 30, 2018 decreased by $265.8 million from December 31, 2017 and decreased $223.9 million from September 30, 2017.
We have short-term borrowing sources available to supplement deposits and meet our funding needs. Such borrowings are generally used to fund our mortgage finance assets, due to their liquidity, short duration and interest spreads available. These borrowing sources include Federal funds purchased from our downstream correspondent bank relationships (which consist of banks that are smaller than our bank) and from our upstream correspondent bank relationships (which consist of banks that are larger than our bank), customer repurchase agreements, and advances from the FHLB and the Federal Reserve. The following table summarizes our short-term borrowings as of September 30, 2018 (in thousands): 
 
 
Federal funds purchased
$
475,842

Repurchase agreements
10,976

FHLB borrowings
3,200,000

Line of credit

Total short-term borrowings
$
3,686,818

Maximum short-term borrowings outstanding at any month-end during 2018
$
4,520,849

The following table summarizes our other borrowing capacities in excess of balances outstanding at September 30, 2018 (in thousands): 
 
 
FHLB borrowing capacity relating to loans
$
4,922,080

FHLB borrowing capacity relating to investment securities
761

Total FHLB borrowing capacity
$
4,922,841

Unused Federal funds lines available from commercial banks
$
722,000


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The following table summarizes our long-term borrowings as of September 30, 2018 (in thousands):
 
 
Subordinated notes
$
281,677

Trust preferred subordinated debentures
113,406

Total long-term borrowings
$
395,083

We have an unsecured, revolving, non-amortizing line of credit with maximum availability of $130.0 million with a maturity date of December 18, 2018. The loan proceeds may be used for general corporate purposes including funding regulatory capital infusions into the Bank. The loan agreement contains customary financial covenants and restrictions. As of September 30, 2018 and December 31, 2017, there were no borrowings outstanding.
Our equity capital, including $150 million in preferred stock, averaged $2.3 billion for the nine months ended September 30, 2018, as compared to $2.1 billion for the same period in 2017. We have not paid any cash dividends on our common stock since we commenced operations and have no plans to do so in the foreseeable future.
As of September 30, 2018, our capital ratios were above the levels required to be well capitalized. We believe that our earnings, periodic capital raising transactions and the addition of loan and deposit relationships will allow us to continue to grow organically.

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Table of Contents


Commitments and Contractual Obligations
The following table presents significant fixed and determinable contractual payment obligations to third parties by payment date. Payments for borrowings do not include interest. Payments related to leases are based on actual payments specified in the underlying contracts. As of September 30, 2018, our significant fixed and determinable contractual obligations to third parties, excluding interest, were as follows (in thousands):
 
 
Within One
Year
 
After One but
Within Three
Years
 
After Three but
Within Five
Years
 
After Five
Years
 
Total
Deposits without a stated maturity
$
18,381,151

 
$

 
$

 
$

 
$
18,381,151

Time deposits
1,983,370

 
20,311

 
355

 
450

 
2,004,486

Federal funds purchased and customer repurchase agreements
486,818

 

 

 

 
486,818

FHLB borrowings
3,200,000

 

 

 

 
3,200,000

Operating lease obligations(1)
16,798

 
33,115

 
30,203

 
32,280

 
112,396

Subordinated notes

 

 

 
281,677

 
281,677

Trust preferred subordinated debentures

 

 

 
113,406

 
113,406

Total contractual obligations
$
24,068,137

 
$
53,426

 
$
30,558

 
$
427,813

 
$
24,579,934


(1)
Non-balance sheet item.
Critical Accounting Policies
SEC guidance requires disclosure of “critical accounting policies.” The SEC defines “critical accounting policies” as those that are most important to the presentation of a company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States. The more significant of these policies are summarized in Note 1 - Operations and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in the 2017 Form 10-K. Not all significant accounting policies require management to make difficult, subjective or complex judgments. However, the policy noted below could be deemed to meet the SEC’s definition of a critical accounting policy.
Allowance for Loan Losses
Management considers the policies related to the allowance for loan losses as the most critical to the financial statement presentation. The total allowance for loan losses includes activity related to allowances calculated in accordance with Accounting Standards Codification (“ASC”) 310, Receivables, and ASC 450, Contingencies. The allowance for loan losses is established through a provision for credit losses charged to current earnings. The amount maintained in the allowance reflects management’s continuing evaluation of the loan losses inherent in the loan portfolio. The allowance for loan losses is comprised of specific reserves assigned to certain classified loans and general reserves. Factors contributing to the determination of specific reserves include the creditworthiness of the borrower, and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral-dependent loans. For purposes of determining the general allowance, the portfolio is segregated by product types in order to recognize differing risk profiles among categories, and then further segregated by credit grades. See “Summary of Loan Loss Experience” above and Note 4 – Loans Held for Investment and Allowance for Loan Losses in the accompanying notes to the consolidated financial statements included elsewhere in this report for further discussion of the risk factors considered by management in establishing the allowance for loan losses.

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Table of Contents

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. These changes may be the result of various factors, including interest rates, foreign exchange rates, commodity prices, or equity prices. Additionally, the financial instruments subject to market risk can be classified either as held for trading purposes or held for other than trading.
We are subject to market risk primarily through the effect of changes in interest rates on our portfolio of assets held for purposes other than trading. Additionally, we have some market risk relative to commodity prices through our energy lending activities. Petroleum and natural gas commodity prices were suppressed throughout 2015 and 2016, but stabilized amidst continuing market uncertainty during 2017 and continuing into 2018. Declines in commodity prices negatively impacted our energy clients' ability to perform on their loan obligations, and further uncertainty and volatility could have a negative impact on our customers and our loan portfolio. Management does not currently expect the current decline in commodity prices to have a material adverse effect on our financial position. Foreign exchange rates, commodity prices and/or equity prices do not pose significant market risk to us.
The responsibility for managing market risk rests with the BSMC, which operates under policy guidelines established by our board of directors. The negative acceptable variation in net interest revenue due to a 200 basis point increase or decrease in interest rates is generally limited by these guidelines to plus or minus 10-15%. These guidelines also establish maximum levels for short-term borrowings, short-term assets and public and brokered deposits. They also establish minimum levels for liquidity, among other things. Oversight of our compliance with these guidelines is the ongoing responsibility of the BSMC, with exceptions reported to the Risk Management Committee, and to our board of directors if deemed necessary, on a quarterly basis. Additionally, the Credit Policy Committee ("CPC") specifically manages risk relative to commodity price market risks. The CPC establishes maximum portfolio concentration levels for energy loans as well as maximum advance rates for energy collateral.
Interest Rate Risk Management
Our interest rate sensitivity is illustrated in the following table. The table reflects rate-sensitive positions as of September 30, 2018, and is not necessarily indicative of positions on other dates. The balances of interest rate sensitive assets and liabilities are presented in the periods in which they next reprice to market rates or mature and are aggregated to show the interest rate sensitivity gap. The mismatch between repricings or maturities within a time period is commonly referred to as the “gap” for that period. A positive gap (asset sensitive), where interest-rate sensitive assets exceed interest rate sensitive liabilities, generally will result in the net interest margin increasing in a rising rate environment and decreasing in a falling rate environment. A negative gap (liability sensitive) will generally have the opposite results on the net interest margin. To reflect anticipated prepayments, certain asset and liability categories are shown in the table using estimated cash flows rather than contractual cash flows. The Company employs interest rate floors in certain variable rate loans to enhance the yield on those loans at times when market interest rates are extraordinarily low. The degree of asset sensitivity, spreads on loans and net interest margin may be reduced until rates increase by an amount sufficient to eliminate the effects of floors. The adverse effect of floors as market rates increase may also be offset by the positive gap, the extent to which rates on deposits and other funding sources lag increasing market rates and changes in composition of funding.

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Table of Contents

Interest Rate Sensitivity Gap Analysis
September 30, 2018
(In thousands)
 
 
0-3 mo
Balance
 
4-12 mo
Balance
 
1-3 yr
Balance
 
3+ yr
Balance
 
Total
Balance
Assets:
 
 
 
 
 
 
 
 
 
Interest-bearing deposits in other banks, federal funds sold and securities purchased under resale agreements
$
2,615,570

 
$

 

 
$

 
$
2,615,570

Investment securities(1)
11,644

 
16,728

 
34,402

 
54,615

 
117,389

Total variable loans
19,626,616

 
33,861

 
1,985

 
832

 
19,663,294

Total fixed loans
577,862

 
1,740,568

 
436,750

 
1,387,436

 
4,142,616

Total loans(2)
20,204,478

 
1,774,429

 
438,735

 
1,388,268

 
23,805,910

Total interest sensitive assets
$
22,831,692

 
$
1,791,157

 
$
473,137

 
$
1,442,883

 
$
26,538,869

Liabilities:
 
 
 
 
 
 
 
 
 
Interest-bearing customer deposits
$
9,821,495

 
$

 
$

 
$

 
$
9,821,495

CDs & IRAs
849,125

 
1,134,245

 
20,311

 
805

 
2,004,486

Traditional brokered deposits
1,528,196

 

 

 

 
1,528,196

Total interest-bearing deposits
12,198,816

 
1,134,245

 
20,311

 
805

 
13,354,177

Repurchase agreements, Federal funds
     purchased, FHLB borrowings, line
     of credit
3,686,818

 

 

 

 
3,686,818

Subordinated notes

 

 

 
281,677

 
281,677

Trust preferred subordinated debentures

 

 

 
113,406

 
113,406

Total borrowings
3,686,818

 

 

 
395,083

 
4,081,901

Total interest sensitive liabilities
$
15,885,634

 
$
1,134,245

 
$
20,311

 
$
395,888

 
$
17,436,078

Gap
$
6,946,058

 
$
656,912

 
$
452,826

 
$
1,046,995

 
$

Cumulative Gap
6,946,058

 
7,602,970

 
8,055,796

 
9,102,791

 
9,102,791

 
 
 
 
 
 
 
 
 
 
Demand deposits
 
 
 
 
 
 
 
 
$
7,031,460

Stockholders’ equity
 
 
 
 
 
 
 
 
2,426,442

Total
 
 
 
 
 
 
 
 
$
9,457,902

 
(1)
Investment securities based on fair market value.
(2)
Loans are stated at gross.
The table above sets forth the balances as of September 30, 2018 for interest-bearing assets, interest-bearing liabilities and the total of non-interest-bearing deposits and stockholders’ equity. While a gap interest table is useful in analyzing interest rate sensitivity, an interest rate sensitivity simulation provides a better illustration of the sensitivity of earnings to changes in interest rates. Earnings are also affected by changing interest rates on the value of funding derived from demand deposits and stockholders’ equity. We perform a sensitivity analysis to identify interest rate risk exposure on net interest income. We quantify and measure interest rate risk exposure using a model to dynamically simulate the effect of changes in net interest income relative to changes in interest rates and loan and deposit account balances over the next twelve months based on three interest rate scenarios. These are a “most likely” rate scenario and two “shock test” scenarios.
The “most likely” rate scenario is based on the consensus forecast of future interest rates published by independent sources. These forecasts incorporate future spot rates and relevant spreads of instruments that are actively traded in the open market. The Federal Reserve’s Federal funds target affects short-term borrowing rates; the prime lending rate and LIBOR are the basis for most of our variable-rate loan pricing. The 10-year mortgage rate is also monitored because of its effect on prepayment speeds for mortgage-backed securities. We believe these are our primary interest rate exposures. We are not currently using derivatives to manage our interest rate exposure.

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Table of Contents

For modeling purposes, as of September 30, 2018, the “shock test” scenarios assume a sustained parallel 100 and 200 basis point increase in interest rates, as well as a 100 basis point decrease in rates. As of September 30, 2017, the scenarios assumed a sustained parallel 100 and 200 basis point increase in interest rates. As short-term rates remained low through 2017, we did not believe that analysis of an assumed decrease in interest rates would provide meaningful results.

Our interest rate risk exposure model incorporates assumptions regarding the level of interest rate or balance changes on indeterminable maturity deposits (demand deposits, interest-bearing transaction accounts and savings accounts) for a given level of market rate changes. Given the current environment of increasing short-term rates, deposit pricing can vary by product and customer. These assumptions have been developed through a combination of historical analysis and future expected pricing behavior. Changes in prepayment behavior of mortgage-backed securities, residential and commercial mortgage loans in each rate environment are captured using industry estimates of prepayment speeds for various coupon segments of the portfolio. The impact of planned growth and new business activities is factored into the simulation model. This modeling indicated interest rate sensitivity as follows (in thousands):
 
 
Anticipated Impact Over the Next Twelve Months as Compared to Most Likely Scenario
 
Anticipated Impact Over the Next Twelve Months as Compared to Most Likely Scenario
 
100 bp Increase
 
200 bp Increase
 
100 bp Decrease
 
100 bp Increase
 
200 bp Increase
 
September 30, 2018
 
September 30, 2017
Change in net interest income
$
106,977

 
$
214,641

 
$
(111,867
)
 
$
114,593

 
$
231,113

The simulations used to manage market risk are based on numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows and customer behavior. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results may differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies, among other factors.

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Table of Contents

ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the supervision and participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based upon that evaluation, we have concluded that, as of the end of such period, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS
We are subject to various claims and legal actions related to operating activities that arise in the ordinary course of business. Management does not currently expect the ultimate disposition of these matters to have a material adverse impact on our financial statements.
 
ITEM 1A.
RISK FACTORS
There have been no material changes in the risk factors previously disclosed in the 2017 Form 10-K.



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ITEM 6.
EXHIBITS
 
(a)
Exhibits
 
31.1
 
31.2
 
32.1
 
32.2
 
101
The following materials from Texas Capital Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2018, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Statements of Income, (ii) Consolidated Balance Sheets, (iii) Consolidated Statements of Cash Flows, and (iv) Notes to Consolidated Financial Statements



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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.
TEXAS CAPITAL BANCSHARES, INC.
Date: October 17, 2018
/s/ Julie Anderson
Julie Anderson
Chief Financial Officer
(Duly authorized officer and principal financial officer)



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