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TEXAS CAPITAL BANCSHARES INC/TX - Quarter Report: 2019 September (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended September 30, 2019
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from              to             
Commission file number 001-34657
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
TX
USA
 
 
75201
(Address of principal executive offices)
 
 
(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)
________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Stock, par value $0.01 per share
 
TCBI
 
Nasdaq Stock Market
6.5% Non-Cumulative Perpetual Preferred Stock Series A, par value $0.01 per share
 
TCBIP
 
Nasdaq Stock Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
x
 
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 16, 2019, 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 50,320,553


Table of Contents

Texas Capital Bancshares, Inc.
Form 10-Q
Quarter Ended September 30, 2019

Index
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
Item 4.
 
 
 
Item 1.
 
Item 1A.
 
Item 6.
 
 





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, 2019
 
December 31, 2018
 
(Unaudited)
 
 
Assets
 
 
 
Cash and due from banks
$
216,085

 
$
214,191

Interest-bearing deposits in other banks
4,968,185

 
2,815,684

Federal funds sold and securities purchased under resale agreements
25,000

 
50,190

Investment securities
238,022

 
120,216

Loans held for sale ($2,667.2 million at September 30, 2019 and $1,969.2 million at December 31, 2018, at fair value)
2,674,225

 
1,969,474

Loans held for investment, mortgage finance
7,951,432

 
5,877,524

Loans held for investment (net of unearned income)
16,772,824

 
16,690,550

Less: Allowance for loan losses
190,138

 
191,522

Loans held for investment, net
24,534,118

 
22,376,552

Mortgage servicing rights, net
49,125

 
42,474

Premises and equipment, net
32,667

 
23,802

Accrued interest receivable and other assets
770,793

 
626,614

Goodwill and intangible assets, net
18,217

 
18,570

Total assets
$
33,526,437

 
$
28,257,767

Liabilities and Stockholders’ Equity
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
10,289,572

 
$
7,317,161

Interest-bearing
17,123,731

 
13,288,952

Total deposits
27,413,303

 
20,606,113

Accrued interest payable
34,336

 
20,675

Other liabilities
285,954

 
194,238

Federal funds purchased and repurchase agreements
139,967

 
641,174

Other borrowings
2,500,000

 
3,900,000

Subordinated notes, net
282,038

 
281,767

Trust preferred subordinated debentures
113,406

 
113,406

Total liabilities
30,769,004

 
25,757,373

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, 2019 and December 31, 2018
150,000

 
150,000

Common stock, $.01 par value:
 
 
 
Authorized shares—100,000,000
 
 
 
Issued shares— 50,318,071 and 50,201,127 at September 30, 2019 and December 31, 2018, respectively
503

 
502

Additional paid-in capital
974,799

 
967,890

Retained earnings
1,623,128

 
1,381,492

Treasury stock (shares at cost: 417 at September 30, 2019 and December 31, 2018)
(8
)
 
(8
)
Accumulated other comprehensive income, net of taxes
9,011

 
518

Total stockholders’ equity
2,757,433

 
2,500,394

Total liabilities and stockholders’ equity
$
33,526,437

 
$
28,257,767

See accompanying notes to consolidated financial statements.

4


Table of Contents

TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND OTHER
COMPREHENSIVE INCOME -UNAUDITED
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands except per share data)
2019
 
2018
 
2019
 
2018
Interest income
 
 
 
 
 
 
 
Interest and fees on loans
$
329,344

 
$
291,189

 
$
971,889

 
$
814,500

Investment securities
2,316

 
1,161

 
6,036

 
1,560

Federal funds sold and securities purchased under resale agreements
554

 
1,018

 
1,090

 
2,808

Interest-bearing deposits in other banks
22,887

 
8,386

 
48,540

 
23,607

Total interest income
355,101

 
301,754

 
1,027,555

 
842,475

Interest expense
 
 
 
 
 
 
 
Deposits
80,967

 
52,034

 
222,550

 
123,343

Federal funds purchased
1,835

 
1,800

 
10,553

 
4,434

Other borrowings
14,703

 
10,317

 
46,681

 
24,481

Subordinated notes
4,191

 
4,191

 
12,573

 
12,573

Trust preferred subordinated debentures
1,237

 
1,237

 
3,863

 
3,457

Total interest expense
102,933

 
69,579

 
296,220

 
168,288

Net interest income
252,168

 
232,175

 
731,335

 
674,187

Provision for credit losses
11,000

 
13,000

 
58,000

 
52,000

Net interest income after provision for credit losses
241,168

 
219,175

 
673,335

 
622,187

Non-interest income
 
 
 
 
 
 
 
Service charges on deposit accounts
2,707

 
3,477

 
8,535

 
9,619

Wealth management and trust fee income
2,330

 
2,065

 
6,468

 
5,996

Brokered loan fees
8,691

 
6,141

 
21,093

 
17,124

Servicing income
3,549

 
4,987

 
9,409

 
15,446

Swap fees
1,196

 
1,355

 
2,828

 
4,269

Net gain/(loss) on sale of loans held for sale
(6,011
)
 
(444
)
 
(12,502
)
 
(7,847
)
Other
7,839

 
7,937

 
38,848

 
18,137

Total non-interest income
20,301

 
25,518

 
74,679

 
62,744

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
80,106

 
77,327

 
234,818

 
222,268

Net occupancy expense
8,125

 
8,362

 
23,914

 
22,952

Marketing
14,753

 
10,214

 
40,548

 
29,127

Legal and professional
11,394

 
10,764

 
31,428

 
29,948

Communications and technology
10,805

 
7,435

 
31,025

 
21,211

FDIC insurance assessment
5,220

 
6,524

 
14,480

 
18,884

Servicing related expenses
8,165

 
4,207

 
19,613

 
12,379

Allowance and other carrying costs for other real estate owned
2

 
(1,864
)
 
2

 
467

Other
10,800

 
13,174

 
35,481

 
37,998

Total non-interest expense
149,370

 
136,143

 
431,309

 
395,234

Income before income taxes
112,099

 
108,550

 
316,705

 
289,697

Income tax expense
23,958

 
22,998

 
67,756

 
60,764

Net income
88,141

 
85,552

 
248,949

 
228,933

Preferred stock dividends
2,438

 
2,438

 
7,313

 
7,313

Net income available to common stockholders
$
85,703

 
$
83,114

 
$
241,636

 
$
221,620

Other comprehensive income (loss)
 
 
 
 
 
 
 
Change in unrealized gain (loss) on available-for-sale debt securities arising during period, before tax
$
884

 
$
(2,223
)
 
$
10,752

 
$
(2,390
)
Income tax expense (benefit) related to unrealized loss on available-for-sale debt securities
186

 
(467
)
 
2,259

 
(502
)
Other comprehensive income (loss), net of tax
698

 
(1,756
)
 
8,493

 
(1,888
)
Comprehensive income
$
88,839

 
$
83,796

 
$
257,442

 
$
227,045

Basic earnings per common share
$
1.70

 
$
1.66

 
$
4.81

 
$
4.45

Diluted earnings per common share
$
1.70

 
$
1.65

 
$
4.80

 
$
4.41

See accompanying notes to consolidated financial statements.

5


Table of Contents

TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY - UNAUDITED
 
Preferred Stock
 
Common Stock
 
Additional
 
 
 
Treasury Stock
 
Accumulated
Other
 
 
 
Paid-in
 
Retained
 
Comprehensive
 
 
(in thousands except share data)
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Earnings
 
Shares
 
Amount
 
Income
 
Total
Balance at June 30, 2018
6,000,000

 
$
150,000

 
50,151,481

 
$
502

 
$
963,732

 
$
1,228,924

 
(417
)
 
$
(8
)
 
$
380

 
$
2,343,530

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 
85,552

 

 

 

 
85,552

Change in unrealized gain on available-for-sale securities, net of taxes of $467

 

 

 

 

 

 

 

 
(1,756
)
 
(1,756
)
Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
83,796

Stock-based compensation expense recognized in earnings

 

 

 

 
2,292

 

 

 

 

 
2,292

Preferred stock dividend

 

 

 

 

 
(2,438
)
 

 

 

 
(2,438
)
Issuance of stock related to stock-based awards

 

 
25,989

 

 
(738
)
 

 

 

 

 
(738
)
Issuance of common stock related to warrants

 

 
207

 

 

 

 

 

 

 

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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at June 30, 2019
6,000,000

 
$
150,000

 
50,297,969

 
$
503

 
$
972,219

 
$
1,537,425

 
(417
)
 
$
(8
)
 
$
8,313

 
$
2,668,452

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 
88,141

 

 

 

 
88,141

Change in unrealized gain on available-for-sale securities, net of taxes of $186

 

 

 

 

 

 

 

 
698

 
698

Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
88,839

Stock-based compensation expense recognized in earnings

 

 

 

 
3,023

 

 

 

 

 
3,023

Preferred stock dividend

 

 

 

 

 
(2,438
)
 

 

 

 
(2,438
)
Issuance of stock related to stock-based awards

 

 
20,102

 

 
(443
)
 

 

 

 

 
(443
)
Issuance of common stock related to warrants

 

 

 

 

 

 

 

 

 

Balance at September 30, 2019
6,000,000

 
$
150,000

 
50,318,071

 
$
503

 
$
974,799

 
$
1,623,128

 
(417
)
 
$
(8
)
 
$
9,011

 
$
2,757,433

See accompanying notes to consolidated financial statements.


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Table of Contents

TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY - UNAUDITED - CONTINUED
 
Preferred Stock
 
Common Stock
 
Additional
 
 
 
Treasury Stock
 
Accumulated
Other
 
 
 
Paid-in
 
Retained
 
Comprehensive
 
 
(in thousands except share data)
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Earnings
 
Shares
 
Amount
 
Income
 
Total
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 on available-for-sale 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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018 (audited)
6,000,000

 
$
150,000

 
50,201,127

 
$
502

 
$
967,890

 
$
1,381,492

 
(417
)
 
$
(8
)
 
$
518

 
$
2,500,394

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 
248,949

 

 

 

 
248,949

Change in unrealized gain on available-for-sale securities, net of taxes of $2,259

 

 

 

 

 

 

 

 
8,493

 
8,493

Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
257,442

Stock-based compensation expense recognized in earnings

 

 

 

 
8,565

 

 

 

 

 
8,565

Preferred stock dividend

 

 

 

 

 
(7,313
)
 

 

 

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

 

 
108,176

 
1

 
(1,656
)
 

 

 

 

 
(1,655
)
Issuance of common stock related to warrants

 

 
8,768

 

 

 

 

 

 

 

Balance at September 30, 2019
6,000,000

 
$
150,000

 
50,318,071

 
$
503

 
$
974,799

 
$
1,623,128

 
(417
)
 
$
(8
)
 
$
9,011

 
$
2,757,433

(1)
Represents the impact of adopting Accounting Standard Update ("ASU") 2018-02 and ASU 2016-01. See Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 for more information.

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Table of Contents

TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
 
Nine months ended September 30,
(in thousands)
2019
 
2018
Operating activities
 
 
 
Net income
$
248,949

 
$
228,933

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
58,000

 
52,000

Depreciation and amortization
25,754

 
24,776

Net (gain)/loss on sale of loans held for sale
12,502

 
7,847

Increase (decrease) in valuation allowance on mortgage servicing rights
8,360

 
(2,823
)
Stock-based compensation expense
12,973

 
15,633

Purchases and originations of loans held for sale
(7,288,823
)
 
(5,012,188
)
Proceeds from sales and repayments of loans held for sale
6,534,879

 
4,321,485

Changes in operating assets and liabilities:
 
 
 
Accrued interest receivable and other assets
(156,472
)
 
(80,731
)
Accrued interest payable and other liabilities
114,282

 
33,920

Net cash used in operating activities
(429,596
)
 
(411,148
)
Investing activities
 
 
 
Purchases of investment securities
(111,131
)
 
(99,295
)
Principal payments received on investment securities
5,534

 
2,998

Originations of mortgage finance loans
(99,799,613
)
 
(73,661,362
)
Proceeds from pay-offs of mortgage finance loans
97,725,705

 
73,491,735

Net increase in loans held for investment, excluding mortgage finance loans
(143,741
)
 
(1,248,423
)
Purchase of premises and equipment, net
(15,047
)
 
(5,655
)
Proceeds from sale of MSRs

 
22,439

Proceeds from sale of other real estate owned, net
79

 
13,645

Net cash used in investing activities
(2,338,214
)
 
(1,483,918
)
Financing activities
 
 
 
Net increase in deposits
6,807,190

 
1,262,457

Costs from issuance of stock related to stock-based awards and warrants
(1,655
)
 
(2,396
)
Preferred dividends paid
(7,313
)
 
(7,313
)
Net increase/(decrease) in other borrowings
(1,400,000
)
 
400,000

Net increase/(decrease) in Federal funds purchased and repurchase agreements
(501,207
)
 
121,778

Net cash provided by financing activities
4,897,015

 
1,774,526

Net increase/(decrease) in cash and cash equivalents
2,129,205

 
(120,540
)
Cash and cash equivalents at beginning of period
3,080,065

 
2,905,591

Cash and cash equivalents at end of period
$
5,209,270

 
$
2,785,051

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for interest
$
282,559

 
$
158,750

Cash paid during the period for income taxes
85,314

 
64,225

See accompanying notes to consolidated financial statements.

8


Table of Contents

(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 or national clientele of commercial borrowers. We are primarily a secured lender, with the majority of our loans held for investment, excluding mortgage finance loans and other national lines of business, being made to businesses headquartered or with operations in Texas. Our national lines of business provide specialized lending products 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, 2018, included in our Annual Report on Form 10-K filed with the SEC on February 14, 2019 (the “2018 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 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 was 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 have elected to apply ASU 2016-02 as of the beginning of the period of adoption (January 1, 2019) and have not restated comparative periods. Of the optional practical expedients available under ASU 2016-02, we have adopted all expedients except for the hindsight practical expedient.
Our operating leases relate primarily to office space and bank branches. As a result of implementing ASU 2016-02, we recognized an operating lease right-of-use ("ROU") asset of $64 million and an operating lease liability of $74 million on January 1, 2019, with no impact on our consolidated statement of income or consolidated statement of cash flows compared to the prior lease accounting model. The ROU asset and operating lease liability are recorded in other assets and other liabilities, respectively, in the consolidated balance sheets. See Note 7 - Leases for additional information.
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 financial instruments and the status of contingencies are particularly susceptible to significant change.

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Table of Contents

(2) Earnings Per Share
The following table presents the computation of basic and diluted earnings per share:
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands except per share data)
2019
 
2018
 
2019
 
2018
Numerator:
 
 
 
 
 
 
 
Net income
$
88,141

 
$
85,552

 
$
248,949

 
$
228,933

Preferred stock dividends
2,438

 
2,438

 
7,313

 
7,313

Net income available to common stockholders
$
85,703

 
$
83,114

 
$
241,636

 
$
221,620

Denominator:
 
 
 
 
 
 
 
Denominator for basic earnings per share—weighted average shares
50,305,844

 
50,163,433

 
50,273,485

 
49,853,515

Effect of employee stock-based awards(1)
110,558

 
207,391

 
119,277

 
240,376

Effect of warrants to purchase common stock

 
10,525

 

 
115,537

Denominator for dilutive earnings per share—adjusted weighted average shares and assumed conversions
50,416,402

 
50,381,349

 
50,392,762

 
50,209,428

Basic earnings per common share
$
1.70

 
$
1.66

 
$
4.81

 
$
4.45

Diluted earnings per common share
$
1.70

 
$
1.65

 
$
4.80

 
$
4.41


(1)
SARs and RSUs outstanding of 107,615 at September 30, 2019 and 4,000 at September 30, 2018 have not been included in diluted earnings per share because to do so would have been antidilutive for the periods presented.
(3) Investment Securities
Available-for-Sale Debt Securities
The following is a summary of available-for-sale debt securities: 
(in thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
September 30, 2019
 
 
 
 
 
 
 
Available-for-sale debt securities:
 
 
 
 
 
 
 
Residential mortgage-backed securities
$
5,594

 
$
324

 
$

 
$
5,918

Tax-exempt asset-backed securities
183,273

 
14,340

 

 
197,613

Credit risk transfer securities
14,713

 

 
(3,258
)
 
11,455

 
$
203,580

 
$
14,664

 
$
(3,258
)
 
$
214,986

 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
Available-for-sale debt securities:
 
 
 
 
 
 
 
Residential mortgage-backed securities
$
6,874

 
$
368

 
$

 
$
7,242

Tax-exempt asset-backed securities
95,518

 
286

 

 
95,804

 
$
102,392

 
$
654

 
$

 
$
103,046


During the first quarter of 2019, we acquired a $92.0 million tax-exempt security backed with underlying cash flows from municipal revenue bonds, as well as $15.0 million in credit risk transfer ("CRT") securities. The securities were all recorded as available-for-sale upon acquisition and subsequently marked to fair value as of quarter end.
CRT securities represent unsecured obligations issued by government sponsored entities ("GSEs") such as Freddie Mac and are designed to transfer mortgage credit risk from the GSE to private investors. CRT securities are structured to be subject to the performance of a reference pool of mortgage loans in which we share in 50% of the first losses with the GSE. If the reference pool incurs losses, the amount we will recover on the notes is reduced by our share of the amount of such losses, which could potentially be up to 100% of the amount outstanding. The CRT securities are generally interest-only for an initial period of time and are restricted from being transferred until a future date.

10


Table of Contents

The amortized cost and estimated fair value of available-for-sale debt securities are presented below by contractual maturity: 
(in thousands, except percentage data)
Less Than
One Year
 
After One
Through
Five Years
 
After Five
Through
Ten Years
 
After Ten
Years
 
Total
September 30, 2019
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities:(1)
 
 
 
 
 
 
 
 
 
Amortized cost
$

 
$
1,135

 
$

 
$
4,459

 
$
5,594

Estimated fair value

 
1,232

 

 
4,686

 
5,918

Weighted average yield(3)
%
 
5.54
%
 
%
 
4.68
%
 
4.86
%
Tax-exempt asset-backed securities:(1)
 
 
 
 
 
 
 
 
 
Amortized Cost

 

 

 
183,273

 
183,273

Estimated fair value

 

 

 
197,613

 
197,613

Weighted average yield(2)(3)
%
 
%
 
%
 
4.20
%
 
4.20
%
CRT securities:(1)
 
 
 
 
 
 
 
 
 
Amortized Cost

 

 

 
14,713

 
14,713

Estimated fair value

 

 

 
11,455

 
11,455

Weighted average yield(3)
%
 
%
 
%
 
2.15
%
 
2.15
%
Total available-for-sale debt securities:
 
 
 
 
 
 
 
 
 
Amortized cost
 
 
 
 
 
 
 
 
$
203,580

Estimated fair value
 
 
 
 
 
 
 
 
$
214,986

 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities:(1)
 
 
 
 
 
 
 
 
 
Amortized cost
$
3

 
$
1,573

 
$

 
$
5,298

 
$
6,874

Estimated fair value
4

 
1,668

 

 
5,570

 
7,242

Weighted average yield(3)
6.50
%
 
5.54
%
 
%
 
4.53
%
 
4.76
%
Tax-exempt asset-backed securities:(1)
 
 
 
 
 
 
 
 
 
Amortized Cost

 

 

 
95,518

 
95,518

Estimated fair value

 

 

 
95,804

 
95,804

Weighted average yield(2)(3)
%
 
%
 
%
 
4.25
%
 
4.25
%
Total available-for-sale debt securities:
 
 
 
 
 
 
 
 
 
Amortized cost
 
 
 
 
 
 
 
 
$
102,392

Estimated fair value
 
 
 
 
 
 
 
 
$
103,046

(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.
The following table discloses our available-for-sale debt securities as of September 30, 2019 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:
September 30, 2019
Less Than 12 Months
 
12 Months or Longer
 
Total
(in thousands)
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
CRT securities
$
11,455

 
$
(3,258
)
 
$

 
$

 
$
11,455

 
$
(3,258
)
At September 30, 2019, the CRT securities were the only available-for-sale debt securities in an unrealized loss position. There were no available-for-sale debt securities in an unrealized loss position at December 31, 2018.

11


Table of Contents

We conduct periodic reviews of securities with unrealized losses to evaluate whether the impairment is other-than-temporary. Unrealized losses that are determined to be temporary in nature are recorded, net of tax, in accumulated other comprehensive income ("AOCI") for available-for-sale debt securities. When we have the intent to sell or we believe we will more likely than not be required to sell an available-for-sale debt security, the entire excess of its amortized cost basis over its fair value is recognized in earnings. For available-for-sale debt securities that we do not intend to sell and are not likely to be required to sell, only the credit-related impairment is recognized in earnings and any non-credit-related impairment is recorded in AOCI.
Based on the results of our periodic review of available-for-sale debt securities in an unrealized loss position at March 31, 2019, we recorded a $331,000 other-than-temporary credit-related impairment on the CRT securities, reducing the amortized cost of the securities. The loss was measured as the excess of the amortized costs basis of the security over the present value of cash flows expected to be collected and was recorded in other non-interest expense. Based on the results of our periodic review at September 30, 2019, no additional other-than-temporary credit-related impairment was recorded. These securities also have unrealized losses, which we do not believe are other-than-temporary. We have evaluated the near-term prospects of the investments in relation to the severity and duration of the unrealized losses and based on that evaluation have determined that we have the ability and intent to hold the investments until recovery of fair value.
Available-for-sale debt securities with carrying values of approximately $3.9 million and $1.4 million were pledged to secure certain customer repurchase agreements and deposits, respectively, at September 30, 2019. The comparative amounts at December 31, 2018 were $4.8 million and $1.7 million, respectively.
Equity Securities
Equity securities consist of Community Reinvestment Act funds and investments related to our non-qualified deferred compensation plan. At September 30, 2019 and December 31, 2018, we had $23.0 million and $17.2 million, respectively, in equity securities recorded at fair value. The following is a summary of unrealized and realized gains/(losses) recognized on equity securities and included in other non-interest income in the consolidated statements of income:
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2019
 
2018
 
2019
 
2018
Net gains/(losses) recognized during the period
$
37

 
$
253

 
$
1,876

 
$
149

Less: Realized net gains/(losses) recognized during the period on equity securities sold
111

 
18

 
87

 
180

Unrealized net gains/(losses) recognized during the period on equity securities still held
$
(74
)
 
$
235

 
$
1,789

 
$
(31
)

(4) Loans Held for Investment and Allowance for Loan Losses
Loans held for investment are summarized by portfolio segment as follows:
(in thousands)
September 30, 2019
 
December 31, 2018
Commercial
$
10,377,952

 
$
10,373,288

Mortgage finance(1)
7,951,432

 
5,877,524

Construction
2,641,019

 
2,120,966

Real estate
3,513,799

 
3,929,117

Consumer
68,033

 
63,438

Equipment leases
266,600

 
312,191

Gross loans held for investment
24,818,835

 
22,676,524

Deferred income (net of direct origination costs)
(94,579
)
 
(108,450
)
Allowance for loan losses
(190,138
)
 
(191,522
)
Total loans held for investment, net
$
24,534,118

 
$
22,376,552


(1)
Balances at September 30, 2019 and December 31, 2018 are stated net of $734.7 million and $193.0 million of participations sold, respectively.

12


Table of Contents

Summary of Loan Loss Experience
The following tables summarize the credit risk profile of our loans held for investment by internally assigned grades and non-accrual status:
(in thousands)
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Equipment Leases
 
Total
September 30, 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
9,986,993

 
$
7,951,432

 
$
2,605,995

 
$
3,404,146

 
$
67,844

 
$
266,101

 
$
24,282,511

Special mention
198,186

 

 
19,324

 
73,927

 
150

 
245

 
291,832

Substandard-accruing
83,502

 

 
15,700

 
24,350

 

 
254

 
123,806

Non-accrual
109,271

 

 

 
11,376

 
39

 

 
120,686

Total loans held for investment
$
10,377,952

 
$
7,951,432

 
$
2,641,019

 
$
3,513,799

 
$
68,033

 
$
266,600

 
$
24,818,835

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
10,034,597

 
$
5,877,524

 
$
2,099,955

 
$
3,850,811

 
$
61,815

 
$
309,775

 
$
22,234,477

Special mention
120,531

 

 
21,011

 
47,644

 

 
2,223

 
191,409

Substandard-accruing
140,297

 

 

 
28,205

 
1,568

 
193

 
170,263

Non-accrual
77,863

 

 

 
2,457

 
55

 

 
80,375

Total loans held for investment
$
10,373,288

 
$
5,877,524

 
$
2,120,966

 
$
3,929,117

 
$
63,438

 
$
312,191

 
$
22,676,524


The allowance for loan losses is comprised of general reserves and specific reserves for impaired loans based on our estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We believe the allowance at September 30, 2019 to be appropriate, given management's assessment of losses inherent in the portfolio as of the evaluation date, the growth in the loan and lease portfolio, current economic conditions in our market areas and other factors.

13


Table of Contents

The following table details activity in the allowance for loan losses, as well as the recorded investment in loans held for investment, by portfolio segment and disaggregated on the basis of our impairment methodology. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
(in thousands)
Commercial
Mortgage
Finance
Construction
Real
Estate
Consumer
Equipment Leases
Additional Qualitative Reserve
Total
Nine months ended September 30, 2019
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
Beginning balance
$
129,442

$

$
19,242

$
33,353

$
425

$
1,829

$
7,231

$
191,522

Provision for loan losses
74,462

1,966

712

(7,916
)
(419
)
(1,491
)
(7,231
)
60,083

Charge-offs
62,678



177


19


62,874

Recoveries
1,337




60

10


1,407

Net charge-offs (recoveries)
61,341



177

(60
)
9


61,467

Ending balance
$
142,563

$
1,966

$
19,954

$
25,260

$
66

$
329

$

$
190,138

Period end allowance for loan losses allocated to:
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$
26,418

$

$

$
101

$
8

$

$

$
26,527

Loans collectively evaluated for impairment
116,145

1,966

19,954

25,159

58

329


163,611

Total
$
142,563

$
1,966

$
19,954

$
25,260

$
66

$
329

$

$
190,138

Period end loans allocated to:
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$
109,271

$

$

$
11,376

$
39

$

$

$
120,686

Loans collectively evaluated for impairment
10,268,681

7,951,432

2,641,019

3,502,423

67,994

266,600


24,698,149

Total
$
10,377,952

$
7,951,432

$
2,641,019

$
3,513,799

$
68,033

$
266,600

$

$
24,818,835

Nine months ended September 30, 2018
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
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 allowance for loan losses 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

Total
$
130,410

$

$
19,604

$
32,695

$
425

$
1,830

$
5,342

$
190,306

Period end loans allocated to:
 
 
 
 
 
 
 
 
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


During 2019, we refined our methodology for calculating the allowance for loan losses to improve the specificity of the risk weights and the risk-weighting process for each product type assigned to the loans in our held for investment portfolio. As a result of these refinements, we believe that management is better able to allocate inherent losses previously accounted for in the additional qualitative reserve component of our allowance for loan losses to specific product types and credit risk grades, thus eliminating the additional qualitative reserve component of our allowance for loan losses in 2019.  Additionally, this improved specificity and consideration of current mortgage market conditions resulted in the allocation of a portion of the company’s provision for loan losses to our mortgage finance loan portfolio for the first time in 2019.

14


Table of Contents

The following tables detail our impaired loans held for investment by portfolio segment. In accordance with ASC 310, Receivables, we have also included all restructured and formerly restructured loans in our impaired loan totals.
(in thousands)
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
September 30, 2019
 
 
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
17,420

 
$
31,270

 
$

 
$
18,902

 
$

Energy loans
18,758

 
28,193

 

 
10,340

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
8,757

 
8,757

 

 
3,750

 

Commercial
908

 
908

 

 
6,500

 

Secured by 1-4 family
1,220

 
1,220

 

 
1,228

 

Consumer

 

 

 

 

Equipment leases

 

 

 

 

Total impaired loans with no allowance recorded
$
47,063

 
$
70,348

 
$

 
$
40,720

 
$

With an allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
28,662

 
$
31,730

 
$
13,483

 
$
24,184

 
$

Energy loans
44,431

 
64,171

 
12,935

 
50,955

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
259

 
259

 
50

 
2,855

 

Commercial

 

 

 

 

Secured by 1-4 family
232

 
232

 
51

 
750

 

Consumer
39

 
39

 
8

 
71

 

Equipment leases

 

 

 

 

Total impaired loans with an allowance recorded
$
73,623

 
$
96,431

 
$
26,527

 
$
78,815

 
$

Combined:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
46,082

 
$
63,000

 
$
13,483

 
$
43,086

 
$

Energy loans
63,189

 
92,364

 
12,935

 
61,295

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
9,016

 
9,016

 
50

 
6,605

 

Commercial
908

 
908

 

 
6,500

 

Secured by 1-4 family
1,452

 
1,452

 
51

 
1,978

 

Consumer
39

 
39

 
8

 
71

 

Equipment leases

 

 

 

 

Total impaired loans
$
120,686

 
$
166,779

 
$
26,527

 
$
119,535

 
$


15


Table of Contents

(in thousands)
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
December 31, 2018
 
 
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
23,367

 
$
55,008

 
$

 
$
16,426

 
$
133

Energy loans
12,188

 
13,363

 

 
17,135

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Commercial
7,388

 
7,388

 

 
3,215

 

Secured by 1-4 family
1,233

 
1,233

 

 
734

 

Consumer

 

 

 

 

Equipment leases

 

 

 

 

Total impaired loans with no allowance recorded
$
44,176

 
$
76,992

 
$

 
$
37,510

 
$
133

With an allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
17,529

 
$
17,564

 
$
4,679

 
$
41,307

 
$

Energy loans
25,344

 
28,105

 
3,573

 
25,672

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
49

 

Commercial

 

 

 
83

 

Secured by 1-4 family
236

 
236

 
48

 
188

 

Consumer
55

 
55

 
10

 
54

 

Equipment leases

 

 

 
275

 

Total impaired loans with an allowance recorded
$
43,164

 
$
45,960

 
$
8,310

 
$
67,628

 
$

Combined:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
40,896

 
$
72,572

 
$
4,679

 
$
57,733

 
$
133

Energy loans
37,532

 
41,468

 
3,573

 
42,807

 

Real estate

 

 

 

 

Market risk

 

 

 
49

 

Commercial
7,388

 
7,388

 

 
3,298

 

Secured by 1-4 family
1,469

 
1,469

 
48

 
922

 

Consumer
55

 
55

 
10

 
54

 

Equipment leases

 

 

 
275

 

Total impaired loans
$
87,340

 
$
122,952

 
$
8,310

 
$
105,138

 
$
133


Average impaired loans outstanding during the nine months ended September 30, 2019 and 2018 totaled $119.5 million and $105.0 million, respectively. As of September 30, 2019 and December 31, 2018, none of our non-accrual loans were earning interest income on a cash basis.

16


Table of Contents

The table below provides an age analysis of our loans held for investment:
(in thousands)
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater Than
90 Days(1)
 
Total Past
Due
 
Non-accrual
 
Current
 
Total
September 30, 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Business loans
$
31,313

 
$
6,039

 
$
19,084

 
$
56,436

 
$
46,082

 
$
8,728,321

 
$
8,830,839

Energy
30,000

 
4,200

 
7,550

 
41,750

 
63,189

 
1,442,174

 
1,547,113

Mortgage finance loans

 

 

 

 

 
7,951,432

 
7,951,432

Construction
 
 
 
 
 
 
 
 
 
 
 
 

Market risk

 
15,700

 

 
15,700

 

 
2,520,335

 
2,536,035

Commercial

 

 

 

 

 
81,159

 
81,159

Secured by 1-4 family

 

 

 

 

 
23,825

 
23,825

Real estate
 
 
 
 
 
 
 
 
 
 
 
 

Market risk
3,129

 
14,004

 
2,061

 
19,194

 
9,016

 
2,294,067

 
2,322,277

Commercial

 

 

 

 
908

 
821,323

 
822,231

Secured by 1-4 family
312

 

 
953

 
1,265

 
1,452

 
366,574

 
369,291

Consumer
277

 
20

 

 
297

 
39

 
67,697

 
68,033

Equipment leases

 

 

 

 

 
266,600

 
266,600

Total loans held for investment
$
65,031

 
$
39,963

 
$
29,648

 
$
134,642

 
$
120,686

 
$
24,563,507

 
$
24,818,835

(1)
Loans past due 90 days and still accruing includes premium finance loans of $9.2 million. These loans are generally secured by obligations of insurance carriers to refund premiums on canceled insurance policies. The receipt of the refund of premiums from the insurance carriers can take 180 days or longer from the cancellation date.
As of September 30, 2019 and December 31, 2018, we did not have any loans considered restructured that were not on non-accrual. Of the non-accrual loans at September 30, 2019 and December 31, 2018, $15.5 million and $20.0 million, respectively, met the criteria for restructured. These loans had no unfunded commitments at their respective balance sheet dates.
The following table details the recorded investment at September 30, 2019 and 2018 of loans that have been restructured during the nine months ended September 30, 2019 and 2018 by type of modification:
 
 
Extended Maturity
 
Adjusted Payment Schedule
 
Total
(in thousands, except number of contracts)
 
Number of Contracts
Balance at Period End
 
Number of Contracts
Balance at Period End
 
Number of Contracts
Balance at Period End
Nine months ended September 30, 2019
 
 
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
 
 
Business loans
 
1

$
1,824

 

$

 
1

$
1,824

Energy loans
 
1

3,941

 


 
1

3,941

Total
 
2

$
5,765

 

$

 
2

$
5,765

 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2018
 
 
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
 
 
Business loans
 

$

 
2

$
2,582

 
$
2

$
2,582

Energy loans
 

$

 
5

$
12,332

 
5

$
12,332

Total
 

$

 
7

$
14,914

 
7

$
14,914


Restructured loans generally include terms to temporarily place the loan on interest only, extend the payment terms or reduce the interest rate. We did not forgive any principal on the above restructured loans. At September 30, 2019, all of the above loans restructured were on non-accrual. The restructuring of the loans did not have a significant impact on our allowance for loan losses at September 30, 2019 or 2018. As of September 30, 2019 and 2018, we did not have any loans that were restructured within the last 12 months that subsequently defaulted.

17


Table of Contents

(5) OREO and Valuation Allowance for Losses on OREO
The table below presents a summary of the activity related to OREO:
 
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
 
2019
 
2018
 
2019
 
2018
Beginning balance
 
$

 
$
9,526

 
$
79

 
$
11,742

Sales
 

 
(11,447
)
 
(79
)
 
(11,663
)
Valuation allowance for OREO
 

 
2,000

 

 

Ending balance
 
$

 
$
79

 
$

 
$
79


(6) Certain Transfers of Financial Assets
The table below presents a reconciliation of the changes in loans held for sale:
 
 
Nine Months Ended September 30,
(in thousands)
 
2019
 
2018
Outstanding balance(1):
 
 
 
 
Beginning balance
 
$
1,949,785

 
$
1,012,580

Loans purchased and originated
 
7,288,823

 
5,012,188

Payments and loans sold
 
(6,571,942
)
 
(4,366,138
)
Ending balance
 
2,666,666

 
1,658,630

Fair value adjustment:
 

 
 
Beginning balance
 
19,689

 
(1,576
)
Increase/(decrease) to fair value
 
(12,130
)
 
(5,124
)
Ending balance
 
7,559

 
(6,700
)
Loans held for sale at fair value
 
$
2,674,225

 
$
1,651,930


(1)
Includes $7.1 million and $299,000 of loans held for sale that are carried at lower of cost or market as of September 30, 2019 and December 31, 2018, respectively, as well as $3.3 million as of December 31, 2017. There were no loans held for sale carried at lower of cost or market as of September 30, 2018.
No loans held for sale were on non-accrual as of September 30, 2019 or December 31, 2018. At September 30, 2019 and December 31, 2018, we had $9.2 million and $16.8 million, respectively, in loans held for sale that were 90 days or more past due. The $9.2 million in loans held for sale that were 90 days or more past due at September 30, 2019 included $7.3 million in loans guaranteed by U.S. government agencies that were purchased 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 $9.2 million were $1.9 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 held for sale on our balance sheet regardless of whether the repurchase option has been exercised. At December 31, 2018, $16.0 million of the $16.8 million in loans held for sale were loans guaranteed by U.S. government agencies that were purchased out of Ginnie Mae securities and recorded as loans held for sale, at fair value, on the balance sheet.

18


Table of Contents

From time to time we retain the right to service the loans sold through our MCA program, creating mortgage servicing rights ("MSRs") which are recorded as assets on our balance sheet. A summary of MSR activity is as follows:
 
Nine months ended September 30,
(in thousands)
2019
 
2018
MSRs:
 
 
 
Balance, beginning of year
$
42,474

 
$
88,150

Capitalized servicing rights
22,610

 
32,871

Amortization
(7,599
)
 
(7,920
)
Sales

 
(26,742
)
Balance, end of period
$
57,485

 
$
86,359

Valuation allowance:
 
 
 
Balance, beginning of year
$

 
$
2,823

Increase (decrease) in valuation allowance
8,360

 
(2,823
)
Balance, end of period
$
8,360

 
$

MSRs, net
$
49,125

 
$
86,359

MSRs, fair value
$
49,125

 
$
98,391


At September 30, 2019 and December 31, 2018, our servicing portfolio of residential mortgage loans had an outstanding principal balance of $5.6 billion and $3.9 billion, respectively.
In connection with the servicing of these loans, we hold deposits in the name of investors 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 bank accounts at the Bank. These deposits, included in total non-interest-bearing deposits on the consolidated balance sheets, were $75.2 million at September 30, 2019 and $37.9 million at December 31, 2018.
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 review the key assumptions used in the discounted cash flow model and make adjustments as necessary to estimate the fair value of the MSRs. At September 30, 2019, the estimated fair value of MSRs was adjusted as a result of the decline in mortgage interest rates experienced in the first nine months of 2019, which resulted in an $8.4 million impairment charge. There was no impairment charge at December 31, 2018. The following summarizes the assumptions used by management to determine the fair value of MSRs:
 
September 30, 2019
 
December 31, 2018
Average discount rates
9.06
%
 
9.55
%
Expected prepayment speeds
14.48
%
 
9.77
%
Weighted-average life, in years
5.3

 
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, 2019
 
December 31, 2018
50 bp adverse change in prepayment speed
$
(6,077
)
 
$
(6,028
)
100 bp adverse change in prepayment speed
(9,340
)
 
(11,629
)

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 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 repurchase, indemnification and make-whole agreements. Our estimated exposure related to those agreements totaled $5.4 million and $1.6

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Table of Contents

million at September 30, 2019 and December 31, 2018, respectively, and is recorded in other liabilities in the consolidated balance sheets. We incurred $4.5 million in losses due to make-whole obligations during the nine months ended September 30, 2019 compared to $187,000 during the nine months ended September 30, 2018. The increase in make-whole obligation losses is primarily related to an increase in early payoffs resulting from the declining interest rate environment.
(7) Leases
Operating leases in which we are the lessee are recorded as operating lease ROU assets and operating lease liabilities, included in other assets and other liabilities, respectively, on our consolidated balance sheets. We do not currently have any significant finance leases in which we are the lessee.
Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate at the lease commencement date. ROU assets are further adjusted for lease incentives. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in net occupancy expense in the consolidated statements of income and other comprehensive income.
Our leases relate primarily to office space and bank branches with remaining lease terms of generally 1 to 13 years. Certain lease arrangements contain extension options which typically range from 5 to 10 years at the then fair market rental rates. As these extension options are not generally considered reasonably certain of exercise, they are not included in the lease term. As of September 30, 2019, operating lease ROU assets and liabilities were $84.3 million and $98.4 million, respectively.
The table below summarizes our net lease cost:
(in thousands)
 
Three months ended 
 September 30, 2019
 
Nine months ended September 30, 2019
Operating lease cost
 
$
3,836

 
$
10,973

Variable lease cost
 
845

 
2,977

Sublease income
 
(32
)
 
(94
)
Net lease cost
 
$
4,649

 
$
13,856

Cash paid for amounts included in the measurement of lease liabilities:
 
 
 
 
Operating cash flows from operating leases
 
$
3,592

 
$
11,054

Non-cash changes in ROU assets
 
$
13,610

 
$
97,898

Non-cash changes in lease liabilities(1)
 
$
13,610

 
$
107,719

(1)
Includes $4.2 million and $87.9 million in lease liabilities from new ROU assets obtained during the three and nine months ended September 30, 2019, respectively.
The table below summarizes other information related to our operating leases:
 
 
September 30, 2019
Weighted-average remaining lease term - operating leases, in years
 
7.3

Weighted-average discount rate - operating leases
 
2.75
%


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Table of Contents

The table below summarizes the maturity of remaining lease liabilities:
(in thousands)
 
September 30, 2019
2019
 
$
3,666

2020
 
16,518

2021
 
17,035

2022
 
16,235

2023
 
16,271

2024 and thereafter
 
39,511

Total lease payments
 
109,236

Less: Interest
 
(10,824
)
Present value of lease liabilities
 
$
98,412


(8) Financial Instruments with Off-Balance Sheet Risk
The table below presents our financial instruments with off-balance sheet risk, as well as the activity in the allowance for off-balance sheet credit losses related to those financial instruments. This allowance is recorded in other liabilities on the consolidated balance sheet.
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2019
 
2018
 
2019
 
2018
Beginning balance of allowance for off-balance sheet credit losses
$
10,790

 
$
10,458

 
$
11,434

 
$
9,071

Provision for off-balance sheet credit losses
(1,439
)
 
(175
)
 
(2,083
)
 
1,212

Ending balance of allowance for off-balance sheet credit losses
$
9,351

 
$
10,283

 
$
9,351

 
$
10,283

 
 
 
 
 
 
 
 
(in thousands)
 
 
 
 
September 30, 2019
 
December 31, 2018
Commitments to extend credit - period end balance
 
 
 
$
8,139,889

 
$
8,030,198

Standby letters of credit - period end balance
 
 
 
$
277,832

 
$
236,537


(9) Regulatory Restrictions
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 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 that fully phased in beginning 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 was fully phased-in on January 1, 2019 at 2.5%. The required phase-in capital conservation buffer during 2018 was 1.875%. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital

21


Table of Contents

distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers.
Quantitative measures established by regulation 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, 2019, that the Company and the Bank meet 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, 2019 and December 31, 2018. 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 change could reduce 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.
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
(dollars in thousands)
 
Capital Amount
Ratio
 
Capital Amount
Ratio
 
Capital Amount
Ratio
 
Capital Amount
Ratio
September 30, 2019
 
 
 
 
 
 
 
 
 
 
 
 
CET1
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
$
2,579,029

8.59
%
 
N/A
N/A
 
$
2,102,394

7.00
%
 
N/A

N/A

Bank
 
2,598,906

8.66
%
 
N/A
N/A
 
2,101,222

7.00
%
 
1,951,135

6.50
%
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
3,318,598

11.05
%
 
N/A
N/A
 
3,153,591

10.50
%
 
N/A

N/A

Bank
 
3,179,785

10.59
%
 
N/A
N/A
 
3,151,833

10.50
%
 
3,001,746

10.00
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
2,837,070

9.45
%
 
N/A
N/A
 
2,552,907

8.50
%
 
N/A

N/A

Bank
 
2,756,947

9.18
%
 
N/A
N/A
 
2,551,484

8.50
%
 
2,401,397

8.00
%
Tier 1 capital (to average assets)(1)
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
2,837,070

8.63
%
 
N/A
N/A
 
1,314,356

4.00
%
 
N/A

N/A

Bank
 
2,756,947

8.39
%
 
N/A
N/A
 
1,313,883

4.00
%
 
1,642,353

5.00
%
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
CET1
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
$
2,330,599

8.58
%
 
$
1,732,501

6.38
%
 
$
1,902,354

7.00
%
 
N/A

N/A

Bank
 
2,340,988

8.62
%
 
1,731,955

6.38
%
 
1,901,755

7.00
%
 
1,765,915

6.50
%
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
3,074,097

11.31
%
 
2,683,679

9.88
%
 
2,853,532

10.50
%
 
N/A

N/A

Bank
 
2,925,872

10.77
%
 
2,682,833

9.88
%
 
2,852,632

10.50
%
 
2,716,793

10.00
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
2,589,374

9.53
%
 
2,140,149

7.88
%
 
2,310,002

8.50
%
 
N/A

N/A

Bank
 
2,499,763

9.20
%
 
2,139,474

7.88
%
 
2,309,274

8.50
%
 
2,173,434

8.00
%
Tier 1 capital (to average assets)(1)
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
2,589,374

9.87
%
 
1,049,694

4.00
%
 
1,049,694

4.00
%
 
N/A

N/A

Bank
 
2,499,763

9.53
%
 
1,049,296

4.00
%
 
1,049,296

4.00
%
 
1,311,620

5.00
%

(1)
The Tier 1 capital ratio (to average assets) is not impacted by the Basel III Capital Rules; however, 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, 2019, our mortgage finance loans were $8.0 billion compared to the average for the quarter ended September 30, 2019 of $8.1 billion. As CET1, Tier 1 and total capital ratios are calculated

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Table of Contents

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 period-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 period-end balance is representative of risk characteristics that would justify higher allocations. However, we monitor our capital allocation to confirm that all capital levels remain above well-capitalized levels.
Dividends that may be paid by banks are routinely restricted by various regulatory authorities. The amount that can be paid in any calendar year without prior approval of our 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 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, 2019, or 2018.
(10) 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, 2019 and 2018:
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2019
 
2018
 
2019
 
2018
Stock-settled awards:
 
 
 
 
 
 
 
SARs
$

 
$
19

 
$
6

 
$
112

RSUs
3,015

 
2,261

 
8,532

 
6,235

Restricted stock
8

 
12

 
27

 
36

Cash-settled performance units
1,005

 
2,144

 
4,408

 
9,250

Total
$
4,028

 
$
4,436

 
$
12,973

 
$
15,633


 
(in thousands except period data)
September 30, 2019
Unrecognized compensation expense related to unvested stock-settled awards
$
26,435

Weighted average period over which expense is expected to be recognized, in years
3.1


(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. The standard describes three levels of inputs that may be used to measure fair value as provided below.

Level 1
Quoted prices in active markets for identical assets or liabilities.
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 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.

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Table of Contents

Assets and liabilities measured at fair value are as follows:
 
Fair Value Measurements Using
(in thousands)
Level 1
 
Level 2
 
Level 3
September 30, 2019
 
 
 
 
 
Available-for-sale debt securities:(1)
 
 
 
 
 
Residential mortgage-backed securities
$

 
$
5,918

 
$

Tax-exempt asset-backed securities

 

 
197,613

CRT securities

 

 
11,455

Equity securities(1)(2)
15,890

 
7,146

 

Loans held for sale(3)

 
2,657,969

 
9,198

Loans held for investment(4)(6)

 

 
56,993

Derivative assets(7)

 
62,726

 

Derivative liabilities(7)

 
60,393

 

Non-qualified deferred compensation plan liabilities(8)
16,790

 

 

 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
Available-for-sale debt securities:(1)
 
 
 
 
 
Residential mortgage-backed securities
$

 
$
7,242

 
$

Tax-exempt asset-backed securities

 

 
95,804

Equity securities(1)(2)
10,262

 
6,908

 

Loans held for sale(3)

 
1,952,760

 
16,415

Loans held for investment(4)(6)

 

 
29,885

OREO(5)(6)

 

 
79

Derivative assets(7)

 
21,806

 

Derivative liabilities(7)

 
41,375

 

Non-qualified deferred compensation plan liabilities(8)
10,148

 

 


(1)
Securities are measured at fair value on a recurring basis, generally monthly, except for tax-exempt asset-backed securities and CRT 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 purchased through our MCA program are measured at fair value on a recurring basis, generally monthly.
(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 generally corresponds to the fair value of the invested assets, and are measured at fair value on a recurring basis, generally monthly.

24


Table of Contents

Level 3 Valuations
The following table presents a reconciliation of the level 3 fair value category measured at fair value on a recurring basis:
 
 
 
 
 
 
 
Net Realized/Unrealized Gains (Losses)
 
 
(in thousands)
Balance at Beginning of Period
 
Purchases / Additions
 
Sales / Reductions
 
Realized
 
Unrealized
 
Balance at End of Period
Three months ended September 30, 2019
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale debt securities:(1)
 
 
 
 
 
 
 
 
 
 
 
Tax-exempt asset-backed securities
$
201,339

 
$

 
$
(4,116
)
 
$

 
$
390

 
$
197,613

CRT securities
$
10,953

 
$

 
$

 
$

 
$
502

 
$
11,455

Loans held for sale(2)
$
10,930

 
$

 
$
(2,056
)
 
$
102

 
$
222

 
$
9,198

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, 2019
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale debt securities:(1)
 
 
 
 
 
 
 
 
 
 
 
Tax-exempt asset-backed securities
$
95,804

 
$
92,010

 
$
(4,254
)
 
$

 
$
14,053

 
$
197,613

CRT securities
$

 
$
15,044

 
$

 
$
(331
)
 
$
(3,258
)
 
$
11,455

Loans held for sale(2)
$
16,415

 
$

 
$
(8,466
)
 
$
450

 
$
799

 
$
9,198

Nine months ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Tax-exempt asset-backed securities(1)
$

 
$
95,521

 
$

 
$

 
$
(2,152
)
 
$
93,369

Loans held for sale(2)
$

 
$
38,430

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

(1)
Unrealized gains/(losses) on available-for-sale debt securities are recorded in AOCI. Realized gains/(losses) are recorded in other non-interest income.
(2)
Realized and unrealized gains/(losses) on loans held for sale are recorded in gain/(loss) on sale of loans held for sale.
Tax-exempt asset-backed securities
The fair value of tax-exempt asset-backed securities is based on a discounted cash flow model, which utilizes Level 3, or unobservable, inputs, the most significant of which were a discount rate and weighted-average life. At September 30, 2019, a discount rate of 3.01% and a weighted-average life of 7.3 years were utilized to determine the fair value of these securities, compared to 4.21% and 9.2 years, respectively, at December 31, 2018.
CRT securities
The fair value of CRT securities is based on a discounted cash flow model, which utilizes Level 3, or unobservable, inputs, the most significant of which were a discount rate and weighted-average life. At September 30, 2019, a discount rate of 4.75% and a weighted-average life of 9.5 years were utilized to determine the fair value of these securities.
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, 2019, the fair value of these loans was calculated using a weighted-average discounted price of 95.3% compared to 92.9% at December 31, 2018.

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Table of Contents

Loans held for investment
Certain impaired loans held for investment are reported at fair value through a specific valuation allowance allocation of the allowance for loan losses based upon the fair value of the underlying collateral. The $57.0 million fair value of loans held for investment at September 30, 2019 reported above includes impaired loans held for investment with a carrying value of $72.6 million that were reduced by specific valuation allowance allocations totaling $15.6 million based on collateral valuations utilizing Level 3 inputs. The $29.9 million fair value of loans held for investment at December 31, 2018 reported above includes impaired loans with a carrying value of $32.2 million that were reduced by specific valuation allowance allocations totaling $2.3 million based on collateral valuations utilizing Level 3 inputs.
OREO
Certain foreclosed assets, upon initial recognition, are recorded at fair value less estimated selling costs. At December 31, 2018, OREO had a carrying value of $79,000, with no specific valuation allowance. 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:
 
September 30, 2019
 
December 31, 2018
(in thousands)
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial assets:
 
 
 
 
 
 
 
   Level 1 inputs:
 
 
 
 
 
 
 
Cash and cash equivalents
$
5,209,270

 
$
5,209,270

 
$
3,080,065

 
$
3,080,065

Investment securities
15,890

 
15,890

 
10,262

 
10,262

   Level 2 inputs:
 
 
 
 
 
 
 
Investment securities
13,064

 
13,064

 
14,150

 
14,150

Loans held for sale
2,657,969

 
2,657,969

 
1,953,059

 
1,953,059

Derivative assets
62,726

 
62,726

 
21,806

 
21,806

   Level 3 inputs:
 
 
 
 
 
 
 
Investment securities
209,068

 
209,068

 
95,804

 
95,804

Loans held for sale
9,198

 
9,198

 
16,415

 
16,415

Loans held for investment, net
24,534,118

 
24,564,623

 
22,376,552

 
22,347,876

Financial liabilities:
 
 
 
 
 
 
 
   Level 2 inputs:
 
 
 
 
 
 
 
Federal funds purchased
127,800

 
127,800

 
629,169

 
629,169

Customer repurchase agreements
12,167

 
12,167

 
12,005

 
12,005

Other borrowings
2,500,000

 
2,500,000

 
3,900,000

 
3,900,000

Subordinated notes
282,038

 
293,472

 
281,767

 
283,349

Trust preferred subordinated debentures
113,406

 
113,406

 
113,406

 
113,406

Derivative liabilities
60,393

 
60,393

 
41,375

 
41,375

   Level 3 inputs:
 
 
 
 
 
 
 
Deposits
27,413,303

 
27,420,277

 
20,606,113

 
20,608,494


The estimated fair value for cash and cash equivalents, variable rate loans and variable rate debt approximates carrying value. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Investment Securities

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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 and CRT securities that are valued using a discounted cash flow 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. 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 notional amounts and estimated fair values of derivative positions outstanding are presented in the following table:
 
September 30, 2019
 
December 31, 2018
 
 
 
Estimated Fair Value
 
 
 
Estimated Fair Value
(in thousands)
Notional
Amount
 
Asset Derivative
Liability Derivative
 
Notional
Amount
 
Asset Derivative
Liability Derivative
Non-hedging derivatives:
 
 
 
 
 
 
 
 
 
Financial institution counterparties:
 
 
 
 
 
 
 
 
 
Commercial loan/lease interest rate swaps
$
1,540,248

 
$
94

$
58,347

 
$
1,579,328

 
$
7,978

$
16,719

Commercial loan/lease interest rate caps
627,149

 
43


 
606,950

 
1,109

4

Foreign currency forward contracts
2,954

 
37

6

 
39,737

 
2,263

59

Customer counterparties:
 
 
 
 
 
 
 
 
 
Commercial loan/lease interest rate swaps
1,540,248

 
58,347

94

 
1,579,328

 
16,719

7,978

Commercial loan/lease interest rate caps
627,149

 

43

 
606,950

 
4

1,109

Foreign currency forward contracts
2,954

 
6

37

 
39,737

 
59

2,263

Economic hedging interest rate derivatives:
 
 
 
 
 
 
 
 
 
Loan purchase commitments
580,472

 
3,590

150

 
167,984

 
1,442

6

Forward sale commitments
2,747,284

 
703

1,810

 
1,928,527

 

21,005

Gross derivatives
 
 
62,820

60,487

 
 
 
29,574

49,143

Offsetting derivative assets/liabilities
 
 
(94
)
(94
)
 
 
 
(7,768
)
(7,768
)
Net derivatives included in the consolidated balance sheets
 
 
$
62,726

$
60,393

 
 
 
$
21,806

$
41,375



The weighted-average received and paid interest rates for interest rate swaps outstanding were as follows:

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September 30, 2019
Weighted-Average Interest Rate
 
December 31, 2018 Weighted-Average Interest Rate
  
Received
 
Paid
 
Received
 
Paid
Non-hedging interest rate swaps
4.03
%
 
3.56
%
 
4.24
%
 
4.20
%

The weighted-average strike rate for outstanding interest rate caps was 3.30% at September 30, 2019 and 3.20% at December 31, 2018.
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 $62.7 million at September 30, 2019 and approximately $18.7 million at December 31, 2018. 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 sale commitments. At September 30, 2019, we had $67.0 million in cash collateral pledged for these derivatives, of which $66.6 million was included in interest-bearing deposits in other banks and $410,000 was included in accrued interest receivable and other assets. At December 31, 2018, we had $25.3 million in cash collateral pledged for these derivatives, of which $11.2 million was included in interest-bearing deposits and $14.1 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 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 12 risk participation agreements where we are a participant bank with a notional amount of $143.0 million at September 30, 2019, compared to 13 risk participation agreements having a notional amount of $149.1 million at December 31, 2018. The maximum estimated exposure to these agreements, assuming 100% default by all obligors, was approximately $4.3 million at September 30, 2019 and $1.5 million at December 31, 2018. The fair value of these exposures was insignificant to the consolidated financial statements at both September 30, 2019 and December 31, 2018. 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 13 risk participation agreements where we are the lead bank having a notional amount of $166.7 million at September 30, 2019, compared to 9 agreements having a notional amount of $114.8 million at December 31, 2018.
(13) New Accounting Standards
ASU 2019-01 "Leases (Topic 842)" ("ASU 2019-1") provides clarifications to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing essential information about leasing transactions. Specifically, ASU 2019-01 (i) allows the fair value of the underlying asset reported by lessors that are not manufacturers or dealers to continue to be its cost and not fair value as measured under the fair value definition, (ii) allows for the cash flows received for sales-type and direct financing leases to continue to be presented as results from investing, and (iii) clarifies that entities do not have to disclose the effect of the lease standard on adoption year interim amounts. ASU 2019-01 will be effective for us on January 1, 2020 and will not have any material impact on our consolidated financial statements.
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 continue to evaluate the impact adoption of ASU 2016-13 will have on our consolidated financial statements and disclosures, and 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 implement this new accounting standard. Early implementation activities focused on data capture and portfolio segmentation and were substantially completed during the third quarter of 2019. Additionally, our primary model/tool was validated during the third quarter, enabling us to complete a parallel run using second quarter 2019 data. Completion of a parallel run using third quarter 2019 data will be completed early in the fourth quarter. During the third quarter, we continued validation of our reasonable and supportable forecast model, as well as refinement and documentation of our end-to-end processes, which we expect to be completed during the fourth quarter of 2019.

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Table of Contents

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 available to us at the time such statements are made. 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, general economic conditions in the United States and in our markets, including the continued impact on our customers from volatility in oil and gas prices, expectations regarding rates of default and 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 loan losses, the impact of changing regulatory requirements and legislative changes 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.
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.
Changing economic conditions or other developments adversely affecting our commercial, entrepreneurial and professional customers.
Adverse economic conditions and other factors affecting our middle market customers and their ability to continue to meet their loan obligations.
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, or increases to our allowance for loan losses as a result of the implementation of CECL.
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 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.
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.
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.
The failure to effectively manage our interest rate risk resulting from unexpectedly large or sudden changes in interest rates, maturity imbalances in our assets and liabilities, potential adverse effects to our borrowers including their

29


Table of Contents

inability to repay loans with increased interest rates and the impact to our net interest income from the increasing cost of interest-bearing deposits.
Uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the potential transition away from LIBOR toward new interest rate benchmarks.
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 2018 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.

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Table of Contents

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 effectively service and manage 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, 2019 and December 31, 2018 and results of operations for the three and nine month periods ended September 30, 2019 and September 30, 2018. This discussion should be read in conjunction with our consolidated financial statements and notes to the financial statements appearing elsewhere in this report.
Results of Operations
Summary of Performance
We reported net income of $88.1 million and net income available to common stockholders of $85.7 million, or $1.70 per diluted common share, for the third quarter of 2019 compared to 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. Return on average common equity (“ROE”) was 13.22% and return on average assets ("ROA") was 1.06% for the third quarter of 2019, compared to 14.68% and 1.31%, respectively, for the third quarter of 2018. The results for the quarter included compression in ROE and ROA driven by larger balances in total mortgage finance loans and liquidity assets.
Net income and net income available to common stockholders for the nine months ended September 30, 2019 totaled $248.9 million and $241.6 million, respectively, or $4.80 per diluted common share, compared to net income and net income available to common stockholders of $228.9 million and $221.6 million, respectively, or $4.41 per diluted common share, for the same period in 2018. ROE was 12.99% and ROA was 1.12% for the nine months ended September 30, 2019 compared to 13.62% and 1.23%, respectively, for the same period in 2018.
Details of the changes in the various components of net income are discussed below.

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QUARTERLY FINANCIAL SUMMARIES – UNAUDITED
Consolidated Daily Average Balances, Average Yields and Rates

 
Three months ended September 30, 2019
 
Three months ended September 30, 2018
(in thousands except percentages)
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Investment securities – taxable
$
39,744

 
$
357

 
3.56
%
 
$
24,221

 
$
191

 
3.14
%
Investment securities – non-taxable(2)
200,090

 
2,480

 
4.92
%
 
91,298

 
1,228

 
5.33
%
Federal funds sold and securities purchased under resale agreements
100,657

 
554

 
2.18
%
 
203,972

 
1,018

 
1.98
%
Interest-bearing deposits in other banks
4,184,217

 
22,887

 
2.17
%
 
1,697,787

 
8,386

 
1.96
%
Loans held for sale
2,555,269

 
26,206

 
4.07
%
 
1,484,459

 
17,272

 
4.62
%
Loans held for investment, mortgage finance
8,118,025

 
68,660

 
3.36
%
 
5,443,829

 
49,715

 
3.62
%
Loans held for investment(1)(2)
16,901,391

 
235,557

 
5.53
%
 
16,331,622

 
225,604

 
5.48
%
Less reserve for loan losses
212,898

 

 

 
179,227

 

 

Loans held for investment, net
24,806,518

 
304,217

 
4.87
%
 
21,596,224

 
275,319

 
5.06
%
Total earning assets
31,886,495

 
356,701

 
4.44
%
 
25,097,961

 
303,414

 
4.80
%
Cash and other assets
1,000,117

 
 
 
 
 
877,954

 
 
 
 
Total assets
$
32,886,612

 
 
 
 
 
$
25,975,915

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
$
3,577,905

 
$
18,442

 
2.04
%
 
$
3,253,310

 
$
13,642

 
1.66
%
Savings deposits
10,331,078

 
45,586

 
1.75
%
 
7,820,742

 
29,930

 
1.52
%
Time deposits
2,706,434

 
16,939

 
2.48
%
 
1,778,831

 
8,462

 
1.89
%
Total interest-bearing deposits
16,615,417

 
80,967

 
1.93
%
 
12,852,883

 
52,034

 
1.61
%
Other borrowings
2,896,477

 
16,538

 
2.27
%
 
2,275,640

 
12,117

 
2.11
%
Subordinated notes
281,979

 
4,191

 
5.90
%
 
281,619

 
4,191

 
5.90
%
Trust preferred subordinated debentures
113,406

 
1,237

 
4.33
%
 
113,406

 
1,237

 
4.33
%
Total interest-bearing liabilities
19,907,279

 
102,933

 
2.05
%
 
15,523,548

 
69,579

 
1.78
%
Demand deposits
9,992,406

 
 
 
 
 
7,940,503

 
 
 
 
Other liabilities
264,506

 
 
 
 
 
116,302

 
 
 
 
Stockholders’ equity
2,722,421

 
 
 
 
 
2,395,562

 
 
 
 
Total liabilities and stockholders’ equity
$
32,886,612

 
 
 
 
 
$
25,975,915

 
 
 
 
Net interest income(2)
 
 
$
253,768

 
 
 
 
 
$
233,835

 
 
Net interest margin
 
 
 
 
3.16
%
 
 
 
 
 
3.70
%
Net interest spread
 
 
 
 
2.39
%
 
 
 
 
 
3.02
%
Loan spread(3)
 
 
 
 
3.48
%
 
 
 
 
 
3.93
%
 
(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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Table of Contents

 
Nine months ended September 30, 2019
 
Nine months ended September 30, 2018
(in thousands except percentages)
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Investment securities – taxable
$
36,452

 
$
918

 
3.37
%
 
$
24,198

 
$
590

 
3.26
%
Investment securities – non-taxable(2)
169,163

 
6,479

 
5.12
%
 
30,767

 
1,228

 
5.33
%
Federal funds sold and securities purchased under resale agreements
64,384

 
1,090

 
2.26
%
 
210,531

 
2,808

 
1.78
%
Interest-bearing deposits in other banks
2,841,699

 
48,540

 
2.28
%
 
1,830,849

 
23,607

 
1.72
%
Loans held for sale
2,392,404

 
79,116

 
4.42
%
 
1,397,121

 
46,833

 
4.48
%
Loans held for investment, mortgage finance
6,705,960

 
178,551

 
3.56
%
 
4,818,342

 
134,133

 
3.72
%
Loans held for investment(1)(2)
16,849,987

 
717,541

 
5.69
%
 
15,883,407

 
637,692

 
5.37
%
Less reserve for loan losses
203,968

 

 

 
184,216

 

 

Loans held for investment, net
23,351,979

 
896,092

 
5.13
%
 
20,517,533

 
771,825

 
5.03
%
Total earning assets
28,856,081

 
1,032,235

 
4.78
%
 
24,010,999

 
846,891

 
4.72
%
Cash and other assets
945,623

 
 
 
 
 
828,147

 
 
 
 
Total assets
$
29,801,704

 
 
 
 
 
$
24,839,146

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
$
3,440,245

 
$
52,480

 
2.04
%
 
$
2,980,386

 
$
32,588

 
1.46
%
Savings deposits
9,332,059

 
128,253

 
1.84
%
 
7,862,053

 
77,342

 
1.32
%
Time deposits
2,317,339

 
41,817

 
2.41
%
 
1,092,975

 
13,413

 
1.64
%
Total interest-bearing deposits
15,089,643

 
222,550

 
1.97
%
 
11,935,414

 
123,343

 
1.38
%
Other borrowings
3,110,761

 
57,234

 
2.46
%
 
2,039,010

 
28,915

 
1.90
%
Subordinated notes
281,890

 
12,573

 
5.96
%
 
281,528

 
12,573

 
5.97
%
Trust preferred subordinated debentures
113,406

 
3,863

 
4.55
%
 
113,406

 
3,457

 
4.08
%
Total interest-bearing liabilities
18,595,700

 
296,220

 
2.13
%
 
14,369,358

 
168,288

 
1.57
%
Demand deposits
8,333,719

 
 
 
 
 
8,034,509

 
 
 
 
Other liabilities
236,136

 
 
 
 
 
109,044

 
 
 
 
Stockholders’ equity
2,636,148

 
 
 
 
 
2,326,235

 
 
 
 
Total liabilities and stockholders’ equity
$
29,801,704

 
 
 
 
 
$
24,839,146

 
 
 
 
Net interest income(2)
 
 
$
736,015

 
 
 
 
 
$
678,603

 
 
Net interest margin
 
 
 
 
3.41
%
 
 
 
 
 
3.78
%
Net interest spread
 
 
 
 
2.65
%
 
 
 
 
 
3.15
%
Loan spread(3)
 
 
 
 
3.65
%
 
 
 
 
 
4.07
%

(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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Table of Contents

Volume/Rate Analysis
The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to differences in the average interest rate on those assets and liabilities.
 
Three months ended September 30, 2019/2018
 
Nine months ended September 30, 2019/2018
 
Net
Change
 
Change due to(1)
 
Net
Change
 
Change Due To(1)
(in thousands)
Volume
 
Yield/Rate(2)
 
Volume
 
Yield/Rate(2)
Interest income:
 
 
 
 
 
 
 
 
 
 
 
Investment securities
$
1,418

 
$
1,526

 
$
(108
)
 
$
5,579

 
$
4,193

 
$
1,386

Loans held for sale
8,934

 
12,470

 
(3,536
)
 
32,283

 
33,316

 
(1,033
)
Loans held for investment, mortgage finance loans
18,945

 
24,400

 
(5,455
)
 
44,418

 
52,497

 
(8,079
)
Loans held for investment
9,953

 
7,870

 
2,083

 
79,849

 
38,387

 
41,462

Federal funds sold and securities purchased under resale agreements
(464
)
 
(516
)
 
52

 
(1,718
)
 
(1,924
)
 
206

Interest-bearing deposits in other banks
14,501

 
12,284

 
2,217

 
24,933

 
14,746

 
10,187

Total
53,287

 
58,034

 
(4,747
)
 
185,344

 
141,215

 
44,129

Interest expense:
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
4,800

 
1,358

 
3,442

 
19,892

 
4,909

 
14,983

Savings deposits
15,656

 
9,618

 
6,038

 
50,911

 
15,373

 
35,538

Time deposits
8,477

 
4,419

 
4,058

 
28,404

 
12,598

 
15,806

Other borrowings
4,421

 
3,302

 
1,119

 
28,319

 
15,140

 
13,179

Long-term debt

 
5

 
(5
)
 
406

 
15

 
391

Total
33,354

 
18,702

 
14,652

 
127,932

 
48,035

 
79,897

Net interest income
$
19,933

 
$
39,332

 
$
(19,399
)
 
$
57,412

 
$
93,180

 
$
(35,768
)
(1)
Yield/rate and volume variances are allocated to yield/rate.
(2)
Taxable equivalent rates used where applicable assuming a 21% tax rate.
Net Interest Income
Net interest income was $252.2 million for the three months ended September 30, 2019 compared to $232.2 million for the same period in 2018. The increase was primarily due to an increase in average earning assets of $6.8 billion, partially offset by an increase in average interest-bearing liabilities of $4.4 billion and the effect of increasing funding costs. The increase in average earning assets included a $1.1 billion increase in average loans held for sale, a $3.2 billion increase in average total loans held for investment, primarily from increases in average mortgage finance loans related to lower long-term interest rates, and an $2.4 billion increase in average liquidity assets. The increase in average interest-bearing liabilities included a $3.8 billion increase in average interest-bearing deposits and a $620.8 million increase in average other borrowings. Net interest margin for the three months ended September 30, 2019 was 3.16% compared to 3.70% for the same period in 2018. The decrease was primarily due to the effect of decreases in interest rates during the third quarter of 2019 on loan yields and higher funding costs compared to the third quarter of 2018.
The yield on total loans held for investment decreased to 4.87% for the three months ended September 30, 2019 compared to 5.06% for the same period in 2018, and the yield on earning assets decreased to 4.44% for the three months ended September 30, 2019 compared to 4.80% for the same period in 2018. The average cost of total deposits and borrowed funds increased to 1.31% for the third quarter of 2019 from 1.10% for the third quarter of 2018. The spread on total earning assets, net of the cost of deposits and borrowed funds, was 3.13% for the third quarter of 2019 compared to 3.70% for the third quarter of 2018. The decrease was primarily a result of an increase in the cost of interest-bearing liabilities coupled with declining loan yields. Total funding costs, including all deposits, long-term debt and stockholders' equity increased to 1.25% for the third quarter of 2019 compared to 1.07% for 2018.

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Table of Contents

Net interest income was $731.3 million for the nine months ended September 30, 2019 compared to $674.2 million for the same period in 2018. The increase was primarily due to an increase in average earning assets of $4.8 billion and the effect of increases in interest rates on loan yields, partially offset by an increase in average interest-bearing liabilities of $4.2 billion and the effect of increasing funding costs. The increase in average earning assets included a $995.3 million increase in average loans held for sale, a $2.8 billion increase in average total loans held for investment and a $864.7 million increase in average liquidity assets. The increase in average interest-bearing liabilities included a $3.2 billion increase in average interest-bearing deposits and a $1.1 billion increase in average other borrowings. Net interest margin for the nine months ended September 30, 2019 was 3.41% compared to 3.78% for 2018. The decrease was primarily due to the effect of increases in interest rates on funding costs outpacing the increase in loan yields.
The yield on total loans held for investment increased to 5.13% for the nine months ended September 30, 2019 compared to 5.03% for the prior year period and the yield on earning assets increased to 4.78% for the nine months ended September 30, 2019 compared to 4.72% for the same period in 2018. The average cost of total deposits and borrowed funds increased to 1.41% for the nine months ended September 30, 2019 from 0.92% for the same period in 2018. The spread on total earning assets, net of the cost of deposits and borrowed funds, was 3.37% for 2019 compared to 3.80% for 2018. The decrease was primarily a result of an increase in the cost of interest-bearing liabilities outpacing the growth in loan yields. Total funding costs, including all deposits, long-term debt and stockholders' equity increased to 1.34% for the nine months ended September 30, 2019 compared to 0.91% for the same period in 2018.
Non-interest Income 
 
Three months ended September 30,
Nine months ended September 30,
(in thousands)
2019
 
2018
2019
 
2018
Service charges on deposit accounts
$
2,707

 
$
3,477

$
8,535

 
$
9,619

Wealth management and trust fee income
2,330

 
2,065

6,468

 
5,996

Brokered loan fees
8,691

 
6,141

21,093

 
17,124

Servicing income
3,549

 
4,987

9,409

 
15,446

Swap fees
1,196

 
1,355

2,828

 
4,269

Net gain/(loss) on sale of loans held for sale
(6,011
)
 
(444
)
(12,502
)
 
(7,847
)
Other(1)
7,839

 
7,937

38,848

 
18,137

Total non-interest income
$
20,301

 
$
25,518

$
74,679

 
$
62,744

(1)
Other non-interest income includes such items as letter of credit fees, bank owned life insurance ("BOLI") income, dividends on FHLB and FRB stock and other general operating income.
Non-interest income decreased by $5.2 million during the three months ended September 30, 2019 to $20.3 million, compared to $25.5 million for the same period in 2018. This decrease was primarily due to a $5.6 million decrease in net gain/(loss) on sale of loans held for sale and a decrease of $1.4 million in servicing income, attributable to a decrease in MSRs associated with our MCA program, partially offset by a $2.6 million increase in brokered loan fees.
Non-interest income increased by $11.9 million during the nine months ended September 30, 2019 to $74.7 million, compared to $62.7 million for the same period in 2018. This increase was primarily due to a $20.7 million increase in other non-interest income, which included the settlement of $15.0 million in legal claims during the nine months ended September 30, 2019, and a $4.0 million increase in brokered loan fees, partially offset by a $6.0 million decrease in servicing income, attributable to a decrease in MSRs, a $4.7 million decrease in net gain/(loss) on sale of loans held for sale, a $1.4 million decrease in swap fees and a $1.1 million decrease in service charges. Swap fees are related to customer swap transactions, are received from the institution that is our counterparty on the transaction and fluctuate from time to time based on the number and volume of transactions closed during the year.
While management expects continued growth in certain components of non-interest income, the future rate of growth could be affected by increased competition from national and regional financial institutions and general economic conditions. In order to achieve continued growth in non-interest income, management from time to time evaluates new products, new lines of business or the expansion of existing lines of business. Any new product introduction or new market entry could place additional demands on capital and managerial resources and introduce new risks to our business.

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Table of Contents

Non-interest Expense 
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2019
 
2018
 
2019
 
2018
Salaries and employee benefits
$
80,106

 
$
77,327

 
$
234,818

 
$
222,268

Net occupancy expense
8,125

 
8,362

 
23,914

 
22,952

Marketing
14,753

 
10,214

 
40,548

 
29,127

Legal and professional
11,394

 
10,764

 
31,428

 
29,948

Communications and technology
10,805

 
7,435

 
31,025

 
21,211

FDIC insurance assessment
5,220

 
6,524

 
14,480

 
18,884

Servicing related expenses
8,165

 
4,207

 
19,613

 
12,379

Allowance and other carrying costs for OREO
2

 
(1,864
)
 
2

 
467

Other(1)
10,800

 
13,174

 
35,481

 
37,998

Total non-interest expense
$
149,370

 
$
136,143

 
$
431,309

 
$
395,234

(1)
Other expense includes such items as courier expenses, regulatory assessments other than FDIC insurance, insurance expenses and other general operating expenses.
Non-interest expense for the three months ended September 30, 2019 increased $13.2 million compared to the same period in 2018. The increase is primarily due to increases in salaries and employee benefits, marketing and communications and technology expenses, all of which were due to general business growth and continued build-out, as well as increases in servicing related expenses and allowance and other carrying costs for OREO, partially offset by decreases in FDIC insurance assessment and other non-interest expense. The increase in servicing related expenses is due to higher amortization expense resulting from higher mortgage prepayment rates, as well as an increase in impairment expense. The increase in allowance and other carrying costs for OREO expense is due to the reversal of a $2.0 million valuation allowance on a property sold during the third quarter of 2018.
Non-interest expense for the nine months ended September 30, 2019 increased $36.1 million compared to 2018. The increase is primarily due to increases in salaries and employee benefits, marketing, legal and professional and communication and technology expenses, all of which were due to general business growth and continued build-out, as well as an increase in servicing related expenses, partially offset by decreases in FDIC insurance assessment and other non-interest expense.
Analysis of Financial Condition
Loans Held for Investment
The following table summarizes our loans held for investment on a gross basis by portfolio segment: 
 
September 30, 2019
 
December 31, 2018
(in thousands)
 
Commercial
$
10,377,952

 
$
10,373,288

Mortgage finance
7,951,432

 
5,877,524

Construction
2,641,019

 
2,120,966

Real estate
3,513,799

 
3,929,117

Consumer
68,033

 
63,438

Equipment leases
266,600

 
312,191

Gross loans held for investment
$
24,818,835

 
$
22,676,524

Deferred income (net of direct origination costs)
(94,579
)
 
$
(108,450
)
Allowance for loan losses
(190,138
)
 
$
(191,522
)
Total loans held for investment, net
$
24,534,118

 
$
22,376,552

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.

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Table of Contents

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, 2019, we had $2.6 billion in syndicated loans, $598.4 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, 2019, $6.1 million of our syndicated loans were on non-accrual.
Portfolio Geographic and Industry Concentrations
Although more than 50% of our total loan exposure is outside of Texas and more than 50% of our deposits are sourced outside of Texas, our Texas concentration remains significant. As of September 30, 2019, a majority of our loans held for investment, excluding mortgage finance loans and other national lines of business, were to businesses with headquarters or operations in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this state. We also make loans to 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.
Non-performing Assets
Non-performing assets include non-accrual loans and leases and repossessed assets. The table below summarizes our non-performing assets by type and by type of property securing the credit: 
(in thousands)
September 30, 2019
 
December 31, 2018
 
September 30, 2018
Non-accrual loans(1)
 
 
 
 
 
Commercial
 
 
 
 
 
Oil and gas properties
$
63,189

 
$
37,532

 
$
31,235

Assets of the borrowers
21,975

 
16,538

 
41,067

Inventory
18,133

 
21,300

 
30,182

Other
5,974

 
2,493

 
2,473

Total commercial
109,271

 
77,863

 
104,957

Real estate


 


 


Commercial property
1,167

 
988

 
1,015

Single family residences
1,452

 
1,469

 
1,500

Hotel/motel
8,757

 

 

Total real estate
11,376

 
2,457

 
2,515

Consumer
39

 
55

 
60

Total non-accrual loans
120,686

 
80,375

 
107,532

OREO

 
79

 
79

Total non-performing assets
$
120,686

 
$
80,454

 
$
107,611

Restructured loans - accruing
$

 
$

 
$

Loans held for investment past due 90 days and accruing(2)
$
29,648

 
$
9,353

 
$
11,295

Loans held for sale past due 90 days and accruing(3)
$
9,187

 
$
16,829

 
$
25,238

(1)
As of September 30, 2019, December 31, 2018 and September 30, 2018, non-accrual loans included $15.5 million, $20.0 million and $22.5 million, respectively, in loans that met the criteria for restructured.
(2)
At September 30, 2019, December 31, 2018 and September 30, 2018, loans past due 90 days and still accruing includes premium finance loans of $9.2 million, $9.2 million and $8.2 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, 2019, we had $58.2 million in loans of this type, compared to $81.7 million at December 31, 2018 and $39.3 million at September 30, 2018.

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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 inherent losses in the loan portfolio at the balance sheet date. We recorded a provision for credit losses of $11.0 million during the third quarter of 2019, compared to $13.0 million in the third quarter of 2018.
The table below presents a summary of our loan loss experience: 
 
Nine months ended September 30, 2019
 
Year ended December 31 2018
 
Nine months ended September 30, 2018
 
(in thousands except percentage and multiple data)
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
Beginning balance
$
191,522

  
$
184,655

  
$
184,655

 
Loans charged-off:
 
 

 
 
 
Commercial
62,678

  
79,692

  
45,273

 
Construction

  

  

 
Real estate
177

  

  

 
Consumer

  
767

  
767

 
Equipment leases
19

  
319

  
319

 
Total charge-offs
62,874

  
80,778

  
46,359

 
Recoveries:
 
 

 
 
 
Commercial
1,337

  
2,468

  
1,069

 
Construction

  

  

 
Real estate

  
69

  
43

 
Consumer
60

  
438

  
78

 
Equipment leases
10

  
33

  
32

 
Total recoveries
1,407

  
3,008

  
1,222

 
Net charge-offs
61,467

  
77,770

  
45,137

 
Provision for loan losses
60,083

  
84,637

  
50,788

 
Ending balance
$
190,138

  
$
191,522

  
$
190,306

 
Allowance for off-balance sheet credit losses:
 
 
 
 
 
 
Beginning balance
$
11,434

  
$
9,071

  
$
9,071

 
Provision for off-balance sheet credit losses
(2,083
)
  
2,363

  
1,212

 
Ending balance
$
9,351

  
$
11,434

  
$
10,283

 
Total allowance for credit losses
$
199,489

 
$
202,956


$
200,589

 
Total provision for credit losses
$
58,000

  
$
87,000

  
$
52,000

 
Allowance for loan losses to LHI
0.77

0.85

0.86

Net charge-offs to average LHI
0.35

0.37

0.29

Total provision for credit losses to average LHI
0.33

0.42

0.34

Recoveries to total charge-offs
2.24

3.72

2.64

Allowance for off-balance sheet credit losses to off-balance sheet credit commitments
0.11

0.14

0.13

Combined allowance for credit losses to LHI
0.81

0.90

0.91

Allowance as a multiple of non-performing loans
1.6

2.4

1.8

The allowance for credit losses, including the allowance for losses on unfunded commitments reported on the consolidated balance sheets in other liabilities, totaled $199.5 million at September 30, 2019, $203.0 million at December 31, 2018 and $200.6 million at September 30, 2018. The combined allowance as a percentage of loans held for investment decreased to 0.81% at September 30, 2019 from 0.91% at September 30, 2018 and 0.90% at December 31, 2018. The decline in the combined allowance as a percentage of loans held for investment for the first nine months of 2019 compared to the first nine months of 2018 is due primarily to an increase in loans held for investment.

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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.
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, repurchase 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 our 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, 2018 and the nine months ended September 30, 2019, 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 FHLB borrowings, which are generally used to fund mortgage finance assets. We also rely on the availability of the mortgage secondary market provided by Ginnie Mae and the GSEs to support the liquidity of our mortgage finance assets.
In accordance with our liquidity strategy, deposit growth and increases in borrowing capacity related to our mortgage finance loans have resulted in accumulating liquidity assets in recent periods. The following table summarizes the composition of liquidity assets:
(in thousands except percentage data)
 
September 30, 2019
 
December 31, 2018
 
September 30, 2018
Federal funds sold and securities purchased under resale agreements
 
$
25,000

 
$
50,190

 
$
30,000

Interest-bearing deposits
 
4,968,185

 
2,815,684

 
2,585,570

Total liquidity assets
 
$
4,993,185

 
$
2,865,874

 
$
2,615,570

Total liquidity assets as a percent of:
 
 
 
 
 
 
Total loans held for investment
 
20.2
%
 
12.7
%
 
11.9
%
Total earning assets
 
15.4
%
 
10.5
%
 
10.0
%
Total deposits
 
18.2
%
 
13.9
%
 
12.8
%
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 customer relationships, 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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Table of Contents

We also have access to incremental deposits through brokered retail certificates of deposit, or CDs. These traditional brokered deposits are generally of short maturities, less than 12 months, 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 thousands)
September 30, 2019
 
December 31, 2018
 
September 30, 2018
Deposits from core customers
$
22,885,756

 
$
17,015,541

 
$
17,044,441

Deposits from core customers as a percent of total deposits
83.5
%
 
82.6
%
 
83.6
%
Relationship brokered deposits
$
2,430,543

 
$
2,027,850

 
$
1,813,000

Relationship brokered deposits as a percent of average total deposits
8.9
%
 
9.8
%
 
8.9
%
Traditional brokered deposits
$
2,097,004

 
$
1,562,722

 
$
1,528,196

Traditional brokered deposits as a percent of total deposits
7.6
%
 
7.6
%
 
7.5
%
Average deposits from core customers(1)
$
19,431,375

 
$
17,504,922

 
$
17,477,759

Average deposits from core customers as a percent of average total deposits
82.9
%
 
86.6
%
 
87.5
%
Average relationship brokered deposits(1)
$
2,190,618

 
$
1,890,824

 
$
1,878,614

Average relationship brokered deposits as a percent of average total deposits
9.4
%
 
9.4
%
 
9.4
%
Average traditional brokered deposits(1)
$
1,801,369

 
$
817,857

 
$
613,550

Average traditional brokered deposits as a percent of average total deposits
7.7
%
 
4.0
%
 
3.1
%
(1)    Annual averages presented for December 31, 2018.
We have access to sources of traditional brokered deposits that we estimate to be $5.3 billion. Based on our internal guidelines, we have chosen to limit our use of these sources to a lesser amount. We have increased our use of traditional brokered deposits in 2018 and 2019 in response to favorable rates available in that market relative to other available funding sources.

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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 loans, 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 and other borrowings:
(in thousands)
 
September 30, 2019
Federal funds purchased
 
$
127,800

Repurchase agreements
 
12,167

FHLB borrowings
 
2,500,000

Line of credit
 

Total short-term borrowings
 
$
2,639,967

Maximum short-term borrowings outstanding at any month-end during 2019
 
5,816,421

The following table summarizes our other borrowing capacities net of balances outstanding. As of September 30, 2019, all are scheduled to mature within one year.
(in thousands)
 
September 30, 2019
FHLB borrowing capacity relating to loans
 
$
9,080,641

FHLB borrowing capacity relating to securities
 
610

Total FHLB borrowing capacity(1)
 
$
9,081,251

Unused Federal funds lines available from commercial banks
 
$
1,340,000

Unused Federal Reserve borrowings capacity
 
$
3,957,357

Unused revolving line of credit(2)
 
$
130,000

(1)
FHLB borrowings are collateralized by a blanket floating lien on certain real estate secured loans, mortgage finance assets and also certain pledged securities.
(2)
Unsecured revolving, non-amortizing line of credit with maturity date of December 17, 2019. 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. No borrowings were made against this line of credit during the nine months ended September 30, 2019.
Our equity capital averaged $2.7 billion for the three months ended September 30, 2019 as compared to $2.4 billion for the same period in 2018. 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.
For additional information regarding our capital and stockholders' equity, see Note 9 - Regulatory Restrictions in the accompanying notes to the consolidated financial statements included elsewhere in this report.

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Commitments and Contractual Obligations
The following table presents, as of September 30, 2019, significant fixed and determinable contractual obligations to third parties by payment date. Amounts in the table do not include accrued or accruing interest. See Note 7 - Leases for details of contractual lease obligations.
(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
 
$
24,669,330

 
$

 
$

 
$

 
$
24,669,330

Time deposits
 
2,692,942

 
49,170

 
1,856

 
5

 
2,743,973

Federal funds purchased and customer repurchase agreements
 
139,967

 

 

 

 
139,967

FHLB borrowings
 
2,500,000

 

 

 

 
2,500,000

Subordinated notes
 

 

 

 
282,038

 
282,038

Trust preferred subordinated debentures
 

 

 

 
113,406

 
113,406

Total contractual obligations
 
$
30,002,239

 
$
49,170

 
$
1,856

 
$
395,449

 
$
30,448,714

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 notes to the consolidated financial statements included in our 2018 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 at the balance sheet date. The allowance for loan losses is comprised of general reserves and specific reserves assigned to certain impaired loans. 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 reserve, 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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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE 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. Declines and volatility in commodity prices negatively impacted our energy clients' ability to perform on their loan obligations in recent years, and further uncertainty and volatility could have a negative impact on our customers and our loan portfolio in future periods. Foreign exchange rates, commodity prices (other than energy) and equity prices are not expected to 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 acceptable negative 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 establish maximum levels for short-term borrowings, short-term assets and public and brokered deposits and 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, 2019, 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 for loans and changes in composition of funding.

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Interest Rate Sensitivity Gap Analysis
September 30, 2019
(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
$
4,993,185

 
$

 
$

 
$

 
$
4,993,185

Investment securities(1)
26,438

 
1,192

 
144

 
210,248

 
238,022

Total variable loans
23,976,894

 
153,583

 
48,530

 
316,018

 
24,495,025

Total fixed loans
238,343

 
1,271,209

 
304,002

 
1,184,481

 
2,998,035

Total loans(2)
24,215,237

 
1,424,792

 
352,532

 
1,500,499

 
27,493,060

Total interest sensitive assets
$
29,234,860

 
$
1,425,984

 
$
352,676

 
$
1,710,747

 
$
32,724,267

Liabilities:
 
 
 
 
 
 
 
 
 
Interest-bearing customer deposits
$
14,379,758

 
$

 
$

 
$

 
$
14,379,758

CDs & IRAs
249,490

 
346,448

 
49,170

 
1,861

 
646,969

Traditional brokered deposits
2,097,004

 

 

 

 
2,097,004

Total interest-bearing deposits
16,726,252

 
346,448

 
49,170

 
1,861

 
17,123,731

Repurchase agreements, Federal funds purchased, FHLB borrowings
2,639,967

 

 

 

 
2,639,967

Subordinated notes

 

 

 
282,038

 
282,038

Trust preferred subordinated debentures

 

 

 
113,406

 
113,406

Total borrowings
2,639,967

 

 

 
395,444

 
3,035,411

Total interest sensitive liabilities
$
19,366,219

 
$
346,448

 
$
49,170

 
$
397,305

 
$
20,159,142

GAP
$
9,868,641

 
$
1,079,536

 
$
303,506

 
$
1,313,442

 
$

Cumulative GAP
$
9,868,641

 
$
10,948,177

 
$
11,251,683

 
$
12,565,125

 
$
12,565,125

 
 
 
 
 
 
 
 
 
 
Demand deposits
 
 
 
 
 
 
 
 
10,289,572

Stockholders’ equity
 
 
 
 
 
 
 
 
2,757,433

Total
 
 
 
 
 
 
 
 
$
13,047,005

(1)
Investment securities based on fair market value.
(2)
Total loans includes loans held for investments, stated at gross, and loans held for sale.

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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 the effects of 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 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; the prime lending rate and LIBOR are the basis for most of our variable-rate loan pricing. The 10-year treasury rate is also monitored because of its effect on prepayment speeds for mortgage-backed securities and MSRs. These are our primary interest rate exposures. We are currently not using derivatives to manage our interest rate exposure.
For modeling purposes, the “shock test” scenarios assume immediate, sustained 100 and 200 basis point increases in interest rates and a 100 basis point decrease in interest rates.
Our interest rate risk exposure model incorporates assumptions regarding the level of interest rate and balance changes on indeterminable maturity deposits (demand deposits, interest-bearing transaction accounts and savings accounts) for a given level of market rate change. In 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 projection of 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:
 
Anticipated Impact Over the Next
Twelve Months as Compared to Most Likely Scenario
 
 
  
September 30, 2019
 
September 30, 2018
(in thousands)
100 bps Increase
 
200 bps Increase
 
100 bps Decrease
 
100 bps Increase
 
200 bps Increase
 
100 bps Decrease
Change in net interest income
$
97,080

 
$
194,542

 
$
(99,756
)
 
$
106,977

 
$
214,641

 
$
(111,867
)
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 will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions, customer behavior and management strategies, among other factors.
Our business relies upon a large volume of loans, derivative contracts and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR to establish their interest rate and/or value. In 2017, the U.K. Financial Conduct Authority announced that it would no longer compel banks to submit rates for the calculation of LIBOR after 2021. The impact of alternatives to LIBOR on the valuations, pricing and operation of our financial instruments is not yet known; however, the primary instruments that may be impacted include loans, securities, borrowings and derivatives indexed to LIBOR that mature after December 31, 2021. We have established a working group, consisting of key stakeholders from throughout the company, to monitor developments relating to LIBOR uncertainty and changes and to guide the Bank's response. This team is currently working to gain an understanding of the specific products, information technology systems, borrowing arrangements and legal agreements that will be impacted by the change.

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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(e) 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, except the following:
During the three months ended March 31, 2019, we converted to a new loan servicing system to replace the existing platform that serviced our $17.1 billion loans held for investment portfolio, excluding mortgage finance loans. The new system was subject to various testing and review procedures before, during and after implementation. As a result of this implementation, we made changes to our processes and procedures which, in turn, resulted in changes to our internal control over financial reporting, including the implementation of additional controls.
PART II - OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
The Company is subject to various claims and legal actions that may arise in the ordinary course of conducting its business. Management does not expect the disposition of any of these matters to have a material adverse impact on the Company’s financial statements or results of operations. 
ITEM 1A.
RISK FACTORS
The Company has described in the 2018 Form 10-K the primary risks related to its business and securities, and periodically updates those risks. Provided below is an update to the Company's risk factors as previously disclosed in the 2018 Form 10-K.
We may be adversely affected by changes in the method of determining the London Interbank Offered Rate (“LIBOR”), or the replacement of LIBOR with an alternative reference rate, for our variable rate loans, derivative contracts and other financial assets and liabilities.
Our business relies upon a large volume of loans, derivative contracts and other financial instruments which are directly or indirectly dependent on LIBOR to establish their interest rate and/or value. The U.K. Financial Conduct Authority announced in 2017 that it would no longer compel banks to submit rates for the calculation of LIBOR after 2021. It is not possible to predict whether banks will continue to provide LIBOR submissions to the administrator of LIBOR, whether LIBOR rates will cease to be published or supported before or after 2021 or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. It is expected that a transition away from the widespread use of LIBOR to alternative rates is likely to occur during the next several years.
While we have established a working group consisting of key stakeholders from throughout the company to monitor developments relating to LIBOR uncertainty and changes and to guide the Bank’s response, the impact of these developments on our business and financial results is not yet known. The transition from LIBOR may cause us to incur increased costs and additional risk. Uncertainty as to the nature of alternative reference rates and as to potential changes in or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans originated prior to 2021. If LIBOR rates are no longer available, any successor or replacement interest rates may perform differently, which may affect our net interest income, change our market risk profile and require changes to our risk, pricing and hedging strategies. Any failure to adequately manage this transition could adversely impact our reputation.

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Table of Contents

ITEM 6.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Exhibits

31.1
31.2
32.1
32.2
101.INS
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH
XBRL Taxonomy Extension Schema Document*
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB
XBRL Taxonomy Extension Label Linkbase Document*
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document*

*
Filed herewith
**
Furnished herewith


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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, 2019
/s/ Julie Anderson
Julie Anderson
Chief Financial Officer
(Duly authorized officer and principal financial officer)

48