Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended September 30, 2017
¨
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from                      to                     
Commission file number 001-34657
 
 
TEXAS CAPITAL BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
 
Delaware
 
75-2679109
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
2000 McKinney Avenue, Suite 700, Dallas, Texas, U.S.A.
 
75201
(Address of principal executive officers)
 
(Zip Code)
214/932-6600
(Registrant’s telephone number,
including area code)
N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
 
ý
 
  
Accelerated Filer
 
¨
 
 
 
 
 
Non-Accelerated Filer
 
¨
  (Do not check if a smaller reporting company)
  
Smaller Reporting Company
 
¨
 
 
 
 
 
 
 
 
Emerging Growth Company
 
¨

 
 
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards 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 18, 2017, 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 49,626,545
 


Table of Contents

Texas Capital Bancshares, Inc.
Form 10-Q
Quarter Ended September 30, 2017
Index
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 2.
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.


2

Table of Contents

PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands except share data)
 
September 30,
2017
 
December 31,
2016
 
(Unaudited)
 
 
Assets
 
 
 
Cash and due from banks
$
143,616

 
$
113,707

Interest-bearing deposits
2,332,537

 
2,700,645

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

 
25,000

Securities, available-for-sale
24,224

 
24,874

Loans held for sale, at fair value
955,983

 
968,929

Loans held for investment, mortgage finance
5,642,285

 
4,497,338

Loans held for investment (net of unearned income)
14,828,406

 
13,001,011

Less: Allowance for loan losses
182,929

 
168,126

Loans held for investment, net
20,287,762

 
17,330,223

Mortgage servicing rights, net
77,630

 
28,536

Premises and equipment, net
23,882

 
19,775

Accrued interest receivable and other assets
511,207

 
465,933

Goodwill and intangible assets, net
19,157

 
19,512

Total assets
$
24,400,998

 
$
21,697,134

Liabilities and Stockholders’ Equity
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
8,263,202

 
$
7,994,201

Interest-bearing
10,818,055

 
9,022,630

Total deposits
19,081,257

 
17,016,831

Accrued interest payable
4,562

 
5,498

Other liabilities
178,599

 
161,223

Federal funds purchased and repurchase agreements
83,496

 
109,575

Other borrowings
2,500,000

 
2,000,000

Subordinated notes, net
281,315

 
281,044

Trust preferred subordinated debentures
113,406

 
113,406

Total liabilities
22,242,635

 
19,687,577

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, 2017 and December 31, 2016
150,000

 
150,000

Common stock, $.01 par value:
 
 
 
Authorized shares – 100,000,000
 
 
 
Issued shares – 49,622,242 and 49,504,079 at September 30, 2017 and December 31, 2016, respectively
496

 
495

Additional paid-in capital
959,251

 
955,468

Retained earnings
1,048,195

 
903,187

Treasury stock (shares at cost: 417 at September 30, 2017 and December 31, 2016)
(8
)
 
(8
)
Accumulated other comprehensive income, net of taxes
429

 
415

Total stockholders’ equity
2,158,363

 
2,009,557

Total liabilities and stockholders’ equity
$
24,400,998

 
$
21,697,134

See accompanying notes to consolidated financial statements.

3



TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME – UNAUDITED
(In thousands except per share data)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Interest income
 
 
 
 
 
 
 
Interest and fees on loans
$
229,116

 
$
177,724

 
$
607,386

 
$
501,673

Securities
341

 
232

 
853

 
739

Federal funds sold and securities purchased under resale agreements
642

 
455

 
1,606

 
1,209

Deposits in other banks
7,544

 
4,081

 
19,935

 
11,116

Total interest income
237,643

 
182,492

 
629,780

 
514,737

Interest expense
 
 
 
 
 
 
 
Deposits
22,435

 
8,950

 
52,261

 
26,743

Federal funds purchased
891

 
126

 
1,869

 
362

Other borrowings
4,835

 
1,733

 
9,757

 
4,265

Subordinated notes
4,191

 
4,191

 
12,573

 
12,573

Trust preferred subordinated debentures
930

 
753

 
2,641

 
2,203

Total interest expense
33,282

 
15,753

 
79,101

 
46,146

Net interest income
204,361

 
166,739

 
550,679

 
468,591

Provision for credit losses
20,000

 
22,000

 
42,000

 
68,000

Net interest income after provision for credit losses
184,361

 
144,739

 
508,679

 
400,591

Non-interest income
 
 
 
 
 
 
 
Service charges on deposit accounts
3,211

 
2,880

 
9,323

 
7,401

Wealth management and trust fee income
1,627

 
1,113

 
4,386

 
3,024

Bank owned life insurance (BOLI) income
615

 
520

 
1,562

 
1,592

Brokered loan fees
6,152

 
7,581

 
17,639

 
18,090

Servicing income
4,486

 
310

 
10,387

 
305

Swap fees
647

 
918

 
3,404

 
2,330

Other
2,265

 
3,394

 
8,181

 
9,203

Total non-interest income
19,003

 
16,716

 
54,882

 
41,945

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
67,882

 
56,722

 
194,039

 
162,904

Net occupancy expense
6,436

 
5,634

 
19,062

 
17,284

Marketing
7,242

 
4,292

 
18,349

 
12,686

Legal and professional
6,395

 
5,333

 
20,975

 
16,883

Communications and technology
6,002

 
6,620

 
24,414

 
19,228

FDIC insurance assessment
6,203

 
6,355

 
16,800

 
17,867

Servicing related expenses
3,897

 
620

 
8,329

 
1,305

Other
10,773

 
9,223

 
30,770

 
27,717

Total non-interest expense
114,830

 
94,799

 
332,738

 
275,874

Income before income taxes
88,534

 
66,656

 
230,823

 
166,662

Income tax expense
29,850

 
23,931

 
78,502

 
59,929

Net income
58,684

 
42,725

 
152,321

 
106,733

Preferred stock dividends
2,438

 
2,438

 
7,313

 
7,313

Net income available to common stockholders
$
56,246

 
$
40,287

 
$
145,008

 
$
99,420

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

 
$
(63
)
 
$
22

 
$
(121
)
Income tax benefit related to net unrealized gain on available-for-sale securities
18

 
(23
)
 
8

 
(43
)
Other comprehensive loss, net of tax
34

 
(40
)
 
14

 
(78
)
Comprehensive income
$
58,718

 
$
42,685

 
$
152,335

 
$
106,655

 
 
 
 
 
 
 
 
Basic earnings per common share
$
1.13

 
$
0.88

 
$
2.93

 
$
2.16

Diluted earnings per common share
$
1.12

 
$
0.87

 
$
2.89

 
$
2.14

See accompanying notes to consolidated financial statements.

4

Table of Contents

TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY - UNAUDITED
(In thousands except share data)
 
Preferred Stock
 
Common Stock
 
 
 
 
 
Treasury Stock
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Shares
 
Amount
 
Accumulated
Other
Comprehensive
Income (Loss),
Net of Taxes
 
Total
Balance at December 31, 2015 (audited)
6,000,000

 
$
150,000

 
45,874,224

 
$
459

 
$
714,546

 
$
757,818

 
(417
)
 
$
(8
)
 
$
718

 
$
1,623,533

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 
106,733

 

 

 

 
106,733

Change in unrealized gain on available-for-sale securities, net of taxes of $43

 

 

 

 

 

 

 

 
(78
)
 
(78
)
Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
106,655

Tax benefit related to exercise of stock-based awards

 

 

 

 
1,213

 

 

 

 

 
1,213

Stock-based compensation expense recognized in earnings

 

 

 

 
3,466

 

 

 

 

 
3,466

Preferred stock dividend

 

 

 

 

 
(7,313
)
 

 

 

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

 

 
135,688

 
1

 
(1,773
)
 

 

 

 

 
(1,772
)
Balance at September 30, 2016
6,000,000

 
$
150,000

 
46,009,912

 
$
460

 
$
717,452

 
$
857,238

 
(417
)
 
$
(8
)
 
$
640

 
$
1,725,782

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016 (audited)
6,000,000

 
$
150,000

 
49,504,079

 
$
495

 
$
955,468

 
$
903,187

 
(417
)
 
$
(8
)
 
$
415

 
$
2,009,557

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 
152,321

 

 

 

 
152,321

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

 

 

 

 

 

 

 

 
14

 
14

Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
152,335

Stock-based compensation expense recognized in earnings

 

 

 

 
5,717

 

 

 

 

 
5,717

Preferred stock dividend

 

 

 

 

 
(7,313
)
 

 

 

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

 

 
84,568

 
1

 
(1,934
)
 

 

 

 

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

 

 
33,595

 

 

 

 

 

 

 

Balance at September 30, 2017
6,000,000

 
$
150,000

 
49,622,242

 
$
496

 
$
959,251

 
$
1,048,195

 
(417
)
 
$
(8
)
 
$
429

 
$
2,158,363

See accompanying notes to consolidated financial statements.

5

Table of Contents

TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS—UNAUDITED
(In thousands) 
 
Nine months ended September 30,
 
2017
 
2016
Operating activities
 
 
 
Net income
$
152,321

 
$
106,733

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
42,000

 
68,000

Depreciation and amortization
19,624

 
16,179

Increase in valuation allowance on mortgage servicing rights
216

 
414

Bank owned life insurance (BOLI) income
(1,562
)
 
(1,592
)
Stock-based compensation expense
15,021

 
6,175

Excess tax benefits from stock-based compensation arrangements

 
(1,328
)
Purchases and originations of loans held for sale
(4,315,065
)
 
(1,927,702
)
Proceeds from sales and repayments of loans held for sale
4,282,910

 
1,352,322

Net (gain) loss on sale of loans held for sale and other assets
1,005

 
(1,307
)
Technology write-off
5,285

 

Changes in operating assets and liabilities:
 
 
 
Accrued interest receivable and other assets
(68,672
)
 
(79,267
)
Accrued interest payable and other liabilities
8,434

 
34,172

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

 
(427,201
)
Investing activities
 
 
 
Purchases of available-for-sale securities
(97,381
)
 
(1,278
)
Maturities and calls of available-for-sale securities
94,775

 
265

Principal payments received on available-for-sale securities
3,278

 
4,528

Originations of mortgage finance loans
(62,284,036
)
 
(74,594,117
)
Proceeds from pay-offs of mortgage finance loans
61,139,089

 
74,599,234

Net increase in loans held for investment, excluding mortgage finance loans
(1,856,253
)
 
(943,534
)
Purchase of premises and equipment, net
(9,056
)
 
(1,526
)
Proceeds from sale of foreclosed assets
767

 
62

Net cash used in investing activities
(3,008,817
)
 
(936,366
)
Financing activities
 
 
 
Net increase in deposits
2,064,426

 
3,060,504

Costs from issuance of stock related to stock-based awards and warrants
(1,933
)
 
(1,772
)
Preferred dividends paid
(7,313
)
 
(7,313
)
Net increase in other borrowings
500,000

 
170,000

Excess tax benefits from stock-based compensation arrangements

 
1,328

Decrease in Federal funds purchased and repurchase agreements
(26,079
)
 
(61,631
)
Net cash provided by financing activities
2,529,101

 
3,161,116

Net increase (decrease) in cash and cash equivalents
(338,199
)
 
1,797,549

Cash and cash equivalents at beginning of period
2,839,352

 
1,790,870

Cash and cash equivalents at end of period
$
2,501,153

 
$
3,588,419

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for interest
$
80,037

 
$
48,119

Cash paid during the period for income taxes
72,485

 
68,716

Transfers from loans/leases to OREO and other repossessed assets

 
18,822

See accompanying notes to consolidated financial statements.

6

Table of Contents

TEXAS CAPITAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—UNAUDITED
(1) OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Business
Texas Capital Bancshares, Inc. (the “Company”), a Delaware corporation, was incorporated in November 1996 and commenced banking operations in December 1998. The consolidated financial statements of the Company include the accounts of Texas Capital Bancshares, Inc. and its wholly owned subsidiary, Texas Capital Bank, National Association (the “Bank”). We serve the needs of commercial businesses and successful professionals and entrepreneurs located in Texas as well as operate several lines of business serving a regional and national clientèle of commercial borrowers. We are primarily a secured lender, with our greatest concentration of loans in Texas.
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. In that regard, ASU 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting," ("ASU 2016-09") became effective for us on January 1, 2017. ASU 2016-09 requires that excess tax benefits and deficiencies be recognized as a component of income taxes within the income statement. Additionally, ASU 2016-09 requires that all income tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows. Previously, income tax benefits at award settlement were reported as a reduction to operating cash flows and an increase to financing cash flows to the extent that those benefits exceeded the income tax benefits reported in earnings during the award's vesting period. We have elected to apply that change in cash flow presentation on a prospective basis. ASU 2016-09 also requires that companies make an accounting policy election regarding forfeitures, to either estimate the number of awards that are expected to vest or account for them when they occur. We have elected to recognize forfeitures as they occur. The impact of this change and that of the remaining provisions of ASU 2016-09 did not have a significant impact on our financial statements.
The consolidated interim financial statements have been prepared without audit. 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, 2016, included in our Annual Report on Form 10-K filed with the SEC on February 17, 2017 (the “2016 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.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for loan losses, the fair value of stock-based compensation awards, the fair value of mortgage servicing rights ("MSRs") and the status of contingencies are particularly susceptible to significant change.

7

Table of Contents


(2) EARNINGS PER COMMON SHARE

The following table presents the computation of basic and diluted earnings per share (in thousands except per share data):
 
 
Three months ended 
 September 30,
 
Nine months ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Numerator:
 
 
 
 
 
 
 
Net income
$
58,684

 
$
42,725

 
$
152,321

 
$
106,733

Preferred stock dividends
2,438

 
2,438

 
7,313

 
7,313

Net income available to common stockholders
56,246

 
40,287

 
$
145,008

 
99,420

Denominator:
 
 
 
 
 
 
 
Denominator for basic earnings per share— weighted average shares
49,607,028

 
45,980,517

 
49,573,456

 
45,931,357

Effect of employee stock-based awards(1)
214,468

 
118,885

 
235,011

 
119,021

Effect of warrants to purchase common stock
429,370

 
410,281

 
431,551

 
382,578

Denominator for dilutive earnings per share—adjusted weighted average shares and assumed conversions
50,250,866

 
46,509,683

 
50,240,018

 
46,432,956

Basic earnings per common share
$
1.13

 
$
0.88

 
$
2.93

 
$
2.16

Diluted earnings per common share
$
1.12

 
$
0.87

 
$
2.89

 
$
2.14

 
(1)
SARs and RSUs outstanding of 6,200 at September 30, 2017 and 319,476 at September 30, 2016 have not been included in diluted earnings per share because to do so would have been anti-dilutive for the periods presented.

8

Table of Contents

(3) SECURITIES
The following is a summary of available-for-sale securities (in thousands):
 
September 30, 2017

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair
Value
Available-for-sale securities:







Residential mortgage-backed securities
$
11,402


$
756

 
$

 
$
12,158

Equity securities(1)
12,161


266

 
(361
)
 
12,066


$
23,563


$
1,022

 
$
(361
)
 
$
24,224

 
 
 
 
 
 
 
 
 
December 31, 2016
 
Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Estimated
Fair
Value
Available-for-sale securities:







Residential mortgage-backed securities
$
14,680

 
$
972

 
$

 
$
15,652

Municipals
275

 

 

 
275

Equity securities(1)
9,280

 
27

 
(360
)
 
8,947


$
24,235

 
$
999

 
$
(360
)
 
$
24,874

(1)
Equity securities consist of Community Reinvestment Act funds and investments related to our non-qualified deferred compensation plan.
The amortized cost and estimated fair value of available-for-sale securities are presented below by contractual maturity (in thousands, except percentage data): 
 
September 30, 2017

Less Than
One Year

After One
Through
Five Years

After Five
Through
Ten Years

After Ten
Years

Total
Available-for-sale:









Residential mortgage-backed securities:(1)









Amortized cost
689

 
396

 
2,177

 
8,140

 
11,402

Estimated fair value
708

 
440

 
2,405

 
8,605

 
12,158

Weighted average yield(3)
4.53
%
 
5.97
%
 
5.48
%
 
3.01
%
 
3.68
%
Equity securities:(4)
 
 
 
 
 
 
 
 
 
Amortized cost
12,161

 

 

 

 
12,161

Estimated fair value
12,066

 

 

 

 
12,066

Total available-for-sale securities:
 
 
 
 
 
 
 
 
 
Amortized cost
 
 
 
 
 
 
 
 
$
23,563

Estimated fair value
 
 
 
 
 
 
 
 
$
24,224


9

Table of Contents

 
December 31, 2016

Less Than
One Year

After One
Through
Five Years

After Five
Through
Ten Years

After Ten
Years

Total
Available-for-sale:









Residential mortgage-backed securities:(1)









Amortized cost
$
9

 
$
2,047

 
$
3,147

 
$
9,477

 
$
14,680

Estimated fair value
9

 
2,104

 
3,495

 
10,044

 
15,652

Weighted average yield(3)
5.50
%
 
4.70
%
 
5.55
%
 
2.84
%
 
3.68
%
Municipals:(2)
 
 
 
 
 
 
 
 
 
Amortized cost
275

 

 

 

 
275

Estimated fair value
275

 

 

 

 
275

Weighted average yield(3)
5.61
%
 
%
 
%
 
%
 
5.61
%
Equity securities:(4)
 
 
 
 
 
 
 
 
 
Amortized cost
9,280

 

 

 

 
9,280

Estimated fair value
8,947

 

 

 

 
8,947

Total available-for-sale securities:
 
 
 
 
 
 
 
 
 
Amortized cost
 
 
 
 
 
 
 
 
$
24,235

Estimated fair value
 
 
 
 
 
 
 
 
$
24,874

(1)
Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
(2)
Yields have been adjusted to a tax equivalent basis assuming a 35% federal tax rate.
(3)
Yields are calculated based on amortized cost.
(4)
These equity securities do not have a stated maturity.
At September 30, 2017, securities with carrying values of $2.7 million and $8.0 million were pledged to secure certain deposits and repurchase agreements, respectively.
The following table discloses, as of September 30, 2017 and December 31, 2016, our investment securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months (in thousands): 
September 30, 2017
Less Than 12 Months

12 Months or Longer

Total
 
Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss
Equity securities
$

 
$

 
$
6,139

 
$
(361
)
 
$
6,139

 
$
(361
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Less Than 12 Months

12 Months or Longer

Total
December 31, 2016
Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss
Equity securities
$
1,015

 
$
(6
)
 
$
6,146

 
$
(354
)
 
$
7,161

 
$
(360
)
At September 30, 2017, we owned one security in an unrealized loss position. The security is a publicly traded equity fund and is subject to market pricing volatility. We do not believe this unrealized loss is “other-than-temporary” as of September 30, 2017. We have evaluated the near-term prospects of the investment in relation to the severity and duration of the impairment and based on that evaluation we have the ability and intent to hold the investment until recovery of fair value.

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Table of Contents

(4) LOANS HELD FOR INVESTMENT AND ALLOWANCE FOR LOAN LOSSES
At September 30, 2017 and December 31, 2016, loans held for investment were as follows (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Commercial
$
8,810,825

 
$
7,291,545

Mortgage finance
5,642,285

 
4,497,338

Construction
2,099,355

 
2,098,706

Real estate
3,683,564

 
3,462,203

Consumer
70,436

 
34,587

Leases
259,720

 
185,529

Gross loans held for investment
20,566,185

 
17,569,908

Deferred income (net of direct origination costs)
(95,494
)
 
(71,559
)
Allowance for loan losses
(182,929
)
 
(168,126
)
Total loans held for investment
$
20,287,762

 
$
17,330,223

Commercial Loans and Leases. Our commercial loan portfolio is comprised of lines of credit for working capital and term loans and leases to finance equipment and other business assets. Our energy production loans are generally collateralized with proven reserves based on appropriate valuation standards and take into account the risk of oil and gas price volatility. Our commercial loans and leases are underwritten after carefully evaluating and understanding the borrower’s ability to operate profitably. Our underwriting standards are designed to promote relationship banking rather than to make loans on a transaction basis. Our lines of credit typically are limited to a percentage of the value of the assets securing the line. Lines of credit and term loans typically are reviewed annually, or more frequently, as needed, and are supported by accounts receivable, inventory, equipment and other assets of our clients’ businesses.
Mortgage Finance Loans. Our mortgage finance loans consist of ownership interests purchased in single-family residential mortgages funded through our mortgage finance group. These loans are typically held on our balance sheet for 10 to 20 days. We have agreements with mortgage lenders and purchase interests in individual loans they originate. All loans are underwritten consistent with established programs for permanent financing with financially sound investors. Substantially all loans are conforming loans. Balances as of September 30, 2017 and December 31, 2016 are stated net of $150.7 million and $839.0 million participations sold, respectively.
Construction Loans. Our construction loan portfolio consists primarily of single- and multi-family residential properties and commercial projects used in manufacturing, warehousing, service or retail businesses. Our construction loans generally have terms of one to three years. We typically make construction loans to developers, builders and contractors that have an established record of successful project completion and loan repayment and have a substantial equity investment in the borrowers. Loan amounts are derived primarily from the Bank's evaluation of expected cash flows available to service debt from stabilized projects under hypothetically stressed conditions. Construction loans are also based in part upon estimates of costs and value associated with the completed project. Sources of repayment for these types of loans may be pre-committed permanent loans from other lenders, sales of developed property, or an interim loan commitment from us until permanent financing is obtained. The nature of these loans makes ultimate repayment sensitive to overall economic conditions. Borrowers may not be able to correct conditions of default in loans, increasing risk of exposure to classification, non-performing status, reserve allocation and actual credit loss and foreclosure. These loans typically have floating rates and commitment fees.
Real Estate Loans. A portion of our real estate loan portfolio is comprised of loans secured by properties other than market risk or investment-type real estate. Market risk loans are real estate loans where the primary source of repayment is expected to come from the sale, permanent financing or lease of the real property collateral. We generally provide temporary financing for commercial and residential property. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Our real estate loans generally have maximum terms of five to seven years, and we provide loans with both floating and fixed rates. We generally avoid long-term loans for commercial real estate held for investment. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Appraised values may be highly variable due to market conditions and the impact of the inability of potential purchasers and lessees to obtain financing and a lack of transactions at comparable values.

11

Table of Contents

At September 30, 2017 and December 31, 2016, we had a blanket floating lien on certain real estate-secured loans, mortgage finance loans and certain securities used as collateral for Federal Home Loan Bank (“FHLB”) borrowings.
Summary of Loan Loss Experience
The allowance for loan losses is comprised of general reserves, specific reserves for impaired loans and an additional qualitative reserve based on our estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We consider the allowance at September 30, 2017 to be appropriate, given management's assessment of losses inherent in the portfolio as of the evaluation date, the significant growth in the loan and lease portfolio, current economic conditions in our market areas and other factors.
The following tables summarize the credit risk profile of our loan portfolio by internally assigned grades and non-accrual status as of September 30, 2017 and December 31, 2016 (in thousands):

September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
8,541,821

 
$
5,642,285

 
$
2,085,300

 
$
3,611,667

 
$
69,974

 
$
242,335

 
$
20,193,382

Special mention
28,288

 

 
14,055

 
34,804

 
369

 

 
77,516

Substandard-accruing
124,329

 

 

 
35,275

 
93

 
17,385

 
177,082

Non-accrual
116,387

 

 

 
1,818

 

 

 
118,205

Total loans held for investment
$
8,810,825

 
$
5,642,285

 
$
2,099,355

 
$
3,683,564

 
$
70,436

 
$
259,720

 
$
20,566,185

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
6,941,310

 
$
4,497,338

 
$
2,074,859

 
$
3,430,346

 
$
34,249

 
$
181,914

 
$
17,160,016

Special mention
69,447

 

 
10,901

 
21,932

 

 
3,532

 
105,812

Substandard-accruing
115,848

 

 
12,787

 
7,516

 
138

 

 
136,289

Non-accrual
164,940

 

 
159

 
2,409

 
200

 
83

 
167,791

Total loans held for investment
$
7,291,545

 
$
4,497,338

 
$
2,098,706

 
$
3,462,203

 
$
34,587

 
$
185,529

 
$
17,569,908


12

Table of Contents


The following table details activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2017 and 2016. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Commercial
 
Mortgage
Finance
 
Construction
 
Real
Estate
 
Consumer
 
Leases
 
Additional Qualitative Reserve
 
Total
Beginning balance
$
128,768

 
$

 
$
13,144

 
$
19,149

 
$
241

 
$
1,124

 
$
5,700

 
$
168,126

Provision for loan losses
21,388

 

 
4,431

 
12,948

 
221

 
2,774

 
1,899

 
43,661

Charge-offs
32,146

 

 
59

 
290

 
180

 

 

 
32,675

Recoveries
3,574

 

 
104

 
74

 
56

 
9

 

 
3,817

Net charge-offs (recoveries)
28,572

 

 
(45
)
 
216

 
124

 
(9
)
 

 
28,858

Ending balance
$
121,584

 
$

 
$
17,620

 
$
31,881

 
$
338

 
$
3,907

 
$
7,599

 
$
182,929

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

 
$

 
$

 
$
26

 
$

 
$

 
$

 
$
24,436

Loans collectively evaluated for impairment
97,174

 

 
17,620

 
31,855

 
338

 
3,907

 
7,599

 
158,493

Ending balance
$
121,584

 
$

 
$
17,620

 
$
31,881

 
$
338

 
$
3,907

 
$
7,599

 
$
182,929

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Commercial
 
Mortgage
Finance
 
Construction
 
Real
Estate
 
Consumer
 
Leases
 
Additional Qualitative Reserve
 
Total
Beginning balance
$
112,446

 
$

 
$
6,836

 
$
13,381

 
$
338

 
$
3,931

 
$
4,179

 
$
141,111

Provision for loan losses
65,446

 

 
1,607

 
1,981

 
(23
)
 
(2,646
)
 
(226
)
 
66,139

Charge-offs
34,232

 

 

 
528

 
40

 

 

 
34,800

Recoveries
7,829

 

 
34

 
36

 
16

 
71

 

 
7,986

Net charge-offs (recoveries)
26,403

 

 
(34
)
 
492

 
24

 
(71
)
 

 
26,814

Ending balance
$
151,489

 
$

 
$
8,477

 
$
14,870

 
$
291

 
$
1,356

 
$
3,953

 
$
180,436

Period end amount allocated to:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$
42,674

 
$

 
$
24

 
$
136

 
$
30

 
$

 
$

 
$
42,864

Loans collectively evaluated for impairment
108,815

 

 
8,453

 
14,734

 
261

 
1,356

 
3,953

 
137,572

Ending balance
$
151,489

 
$

 
$
8,477

 
$
14,870

 
$
291

 
$
1,356

 
$
3,953

 
$
180,436

The table below presents the activity in the portion of the allowance for credit losses related to losses on unfunded commitments for the three and nine months ended September 30, 2017 and 2016 (in thousands). This liability is recorded in other liabilities in the consolidated balance sheet.
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Beginning balance
 
$
9,205

 
$
9,355

 
$
11,422

 
$
9,011

Provision for off-balance sheet credit losses
 
556

 
1,517

 
(1,661
)
 
1,861

Ending balance
 
$
9,761

 
$
10,872

 
$
9,761

 
$
10,872


13

Table of Contents

We have traditionally maintained an additional qualitative reserve component to compensate for the uncertainty and complexity in estimating loan and lease losses including factors and conditions that may not be fully reflected in the determination and application of the allowance allocation percentages. The increase in the additional qualitative reserve at September 30, 2017 was primarily driven by a $4.5 million provision related to the potential impact to our loan portfolio from Hurricanes Harvey and Irma ("Hurricanes"). This qualitative factor serves to measure 1) the impact on incurred credit losses resulting from the Hurricanes and 2) the imprecision in the identification and measurement of loans impacted by the Hurricanes. We believe the level of additional qualitative reserve at September 30, 2017 is warranted due to the continued uncertain economic environment which has produced losses, including those resulting from borrowers' misstatement of financial information or inaccurate certification of collateral values. Such losses are not necessarily correlated with historical loss trends or general economic conditions. Our methodology used to calculate the allowance considers historical losses; however, the historical loss rates for specific product types or credit risk grades may not fully incorporate the effects of continued uncertainty regarding the economy or the complete identification of loans impacted by the aforementioned weather events.
Our recorded investment in loans as of September 30, 2017December 31, 2016 and September 30, 2016 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of our impairment methodology was as follows (in thousands):
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Loans individually evaluated for impairment
$
117,426

 
$

 
$

 
$
2,117

 
$

 
$

 
$
119,543

Loans collectively evaluated for impairment
8,693,399

 
5,642,285

 
2,099,355

 
3,681,447

 
70,436

 
259,720

 
20,446,642

Total
$
8,810,825

 
$
5,642,285

 
$
2,099,355

 
$
3,683,564

 
$
70,436

 
$
259,720

 
$
20,566,185

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Loans individually evaluated for impairment
$
166,669

 
$

 
$
159

 
$
3,751

 
$
200

 
$
83

 
$
170,862

Loans collectively evaluated for impairment
7,124,876

 
4,497,338

 
2,098,547

 
3,458,452

 
34,387

 
185,446

 
17,399,046

Total
$
7,291,545

 
$
4,497,338

 
$
2,098,706

 
$
3,462,203

 
$
34,587

 
$
185,529

 
$
17,569,908

 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Loans individually evaluated for impairment
$
168,014

 
$

 
$
159

 
$
3,787

 
$
200

 
$

 
$
172,160

Loans collectively evaluated for impairment
6,885,965

 
4,961,159

 
2,150,294

 
3,388,044

 
27,354

 
96,878

 
17,509,694

Total
$
7,053,979

 
$
4,961,159

 
$
2,150,453

 
$
3,391,831

 
$
27,554

 
$
96,878

 
$
17,681,854


Generally we place loans on non-accrual when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is reversed. Interest income is subsequently recognized on a cash basis as long as the remaining unpaid principal amount of the loan is deemed to be fully collectible. If collectability is questionable, then cash payments are applied to principal. As of September 30, 2017, none of our non-accrual loans were earning on a cash basis compared to $811,000 at December 31, 2016. A loan is placed back on accrual status when both principal and interest are current and it is probable that we will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.

14

Table of Contents

A loan held for investment is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due (both principal and interest) according to the terms of the original loan agreement. In accordance with ASC 310, Receivables, we have also included all restructured and formerly restructured loans in our impaired loan totals. The following tables detail our impaired loans, by portfolio class, as of September 30, 2017 and December 31, 2016 (in thousands):
September 30, 2017
 
 
 
 
 
 
 
 
 
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
23,561

 
$
24,983

 
$

 
$
23,513

 
$

Energy
32,378

 
37,221

 

 
39,196

 

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Commercial
1,700

 
1,700

 

 
2,388

 

Secured by 1-4 family

 

 

 

 

Consumer

 

 

 

 

Leases

 

 

 

 

Total impaired loans with no allowance recorded
$
57,639

 
$
63,904

 
$

 
$
65,097

 
$

With an allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
12,267

 
$
12,267

 
$
3,226

 
$
15,689

 
$

Energy
49,220

 
62,259

 
21,184

 
53,839

 
6

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
35

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
299

 
299

 
6

 
548

 

Commercial

 

 

 

 

Secured by 1-4 family
118

 
118

 
20

 
649

 

Consumer

 

 

 
44

 

Leases

 

 

 
18

 

Total impaired loans with an allowance recorded
$
61,904

 
$
74,943

 
$
24,436

 
$
70,822

 
$
6

Combined:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
35,828

 
$
37,250

 
$
3,226

 
$
39,202

 
$

Energy
81,598

 
99,480

 
21,184

 
93,035

 
6

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
35

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
299

 
299

 
6

 
548

 

Commercial
1,700

 
1,700

 

 
2,388

 

Secured by 1-4 family
118

 
118

 
20

 
649

 

Consumer

 

 

 
44

 

Leases

 

 

 
18

 

Total impaired loans
$
119,543

 
$
138,847

 
$
24,436

 
$
135,919

 
$
6


15

Table of Contents

December 31, 2016
 
 
 
 
 
 
 
 
 
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
23,868

 
$
27,992

 
$

 
$
12,361

 
$

Energy
46,753

 
54,522

 

 
54,075

 

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
2,778

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Commercial
2,083

 
2,083

 

 
4,483

 
38

Secured by 1-4 family

 

 

 

 

Consumer

 

 

 

 

Leases

 

 

 
403

 

Total impaired loans with no allowance recorded
$
72,704

 
$
84,597

 
$

 
$
74,100

 
$
38

With an allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
21,303

 
$
21,303

 
$
7,055

 
$
22,277

 
$

Energy
74,745

 
88,987

 
27,350

 
73,637

 
24

Construction
 
 
 
 
 
 
 
 
 
Market risk
159

 
159

 
24

 
53

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
1,342

 
1,342

 
20

 
3,000

 

Commercial

 

 

 

 

Secured by 1-4 family
326

 
326

 
113

 
435

 

Consumer
200

 
200

 
30

 
67

 

Leases
83

 
83

 
13

 
548

 

Total impaired loans with an allowance recorded
$
98,158

 
$
112,400

 
$
34,605

 
$
100,017

 
$
24

Combined:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
45,171

 
$
49,295

 
$
7,055

 
$
34,638

 
$

Energy
121,498

 
143,509

 
27,350

 
127,712

 
24

Construction
 
 
 
 
 
 
 
 
 
Market risk
159

 
159

 
24

 
2,831

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
1,342

 
1,342

 
20

 
3,000

 

Commercial
2,083

 
2,083

 

 
4,483

 
38

Secured by 1-4 family
326

 
326

 
113

 
435

 

Consumer
200

 
200

 
30

 
67

 

Leases
83

 
83

 
13

 
951

 

Total impaired loans
$
170,862

 
$
196,997

 
$
34,605

 
$
174,117

 
$
62



16

Table of Contents

Average impaired loans outstanding during the nine months ended September 30, 2017 and 2016 totaled $135.9 million and $174.9 million, respectively.
The table below provides an age analysis of our loans held for investment as of September 30, 2017 (in thousands):
 
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater
Than 90
Days and
Accruing(1)
 
Total Past
Due
 
Non-accrual
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Business loans
$
25,301

 
$
18,704

 
$
8,892

 
$
52,897

 
$
34,789

 
$
7,635,061

 
$
7,722,747

Energy
9,950

 
4,484

 

 
14,434

 
81,598

 
992,046

 
1,088,078

Mortgage finance loans

 

 

 

 

 
5,642,285

 
5,642,285

Construction
 
 
 
 
 
 
 
 
 
 
 
 
 
Market risk
663

 

 

 
663

 

 
2,074,537

 
2,075,200

Secured by 1-4 family

 

 

 

 

 
24,155

 
24,155

Real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Market risk
1,301

 

 

 
1,301

 

 
2,639,169

 
2,640,470

Commercial
1,839

 

 

 
1,839

 
1,700

 
782,185

 
785,724

Secured by 1-4 family
2,798

 

 

 
2,798

 
118

 
254,454

 
257,370

Consumer

 

 

 

 

 
70,436

 
70,436

Leases
11,701

 

 

 
11,701

 

 
248,019

 
259,720

Total loans held for investment
$
53,553

 
$
23,188

 
$
8,892

 
$
85,633

 
$
118,205

 
$
20,362,347

 
$
20,566,185

 
(1)
Loans past due 90 days and still accruing includes premium finance loans of $8.4 million. These loans are generally secured by obligations of insurance carriers to refund premiums on canceled insurance policies. The refund of premiums from the insurance carriers can take 180 days or longer from the cancellation date.
Restructured loans are loans on which, due to the borrower’s financial difficulties, we have granted a concession that we would not otherwise consider for borrowers of similar credit quality. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of the two. Modifications of terms that could potentially qualify as a restructuring include reduction of the contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current rate for new debt with similar risk, a reduction of the face amount of debt or forgiveness of either principal or accrued interest. At September 30, 2017 and December 31, 2016, we did not have any loans considered restructured that were not on non-accrual. Of the non-accrual loans at September 30, 2017 and December 31, 2016, $12.0 million and $18.1 million, respectively, met the criteria for restructured. These loans had no unfunded commitments at their respective balance sheet dates. A loan continues to qualify as restructured until a consistent payment history or change in borrower’s financial condition has been evidenced, generally over no less than twelve months. Assuming that the restructuring agreement specifies an interest rate at the time of the restructuring that is greater than or equal to the rate that we are willing to accept for a new extension of credit with comparable risk, then the loan no longer has to be considered a restructuring if it is in compliance with the modified terms in calendar years after the year of the restructure.

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The following table summarizes, for the nine months ended September 30, 2017 and 2016, loans that were restructured during 2017 and 2016 (in thousands):
 
September 30, 2017
 
 
 
 
 
 
Number of Restructured Loans
 
Balance at Restructure
 
Balance at Period-End
Energy loans
1

 
$
1,070

 
$

Commercial business loans
1

 
$
599

 
$
721

Total new restructured loans in 2017
2

 
$
1,669

 
$
721

 
 
 
 
 
 
September 30, 2016
 
 
 
 
 
 
Number of Restructured Loans
 
Balance at Restructure
 
Balance at Period-End
Energy loans
2

 
$
14,235

 
$
13,289

Total new restructured loans in 2016
2

 
$
14,235

 
$
13,289

The restructured loans generally include terms to temporarily place loans on interest only, extend the payment terms or reduce the interest rate. We did not forgive any principal on the above loans. The restructuring of the loans did not have a significant impact on our allowance for loan losses at September 30, 2017 or 2016.
The following table provides information on how restructured loans were modified during the nine months ended September 30, 2017 and 2016 (in thousands):
 
 
Nine months ended September 30,
 
2017
 
2016
Extended maturity
$
721

 
$

Adjusted payment schedule

 
12,647

Combination of maturity extension and payment schedule adjustment

 
642

Other

 

Total
$
721

 
$
13,289

As of September 30, 2017 and 2016, we did not have any loans that were restructured within the last 12 months that subsequently defaulted.
(5) OREO AND VALUATION ALLOWANCE FOR LOSSES ON OREO
The table below presents a summary of the activity related to OREO (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Beginning balance
$
18,689

 
$
18,727

 
$
18,961

 
$
278

Additions

 
282

 

 
18,822

Sales
(457
)
 

 
(729
)
 
(91
)
Valuation allowance for OREO
(101
)
 

 
(101
)
 

Ending balance
$
18,131

 
$
19,009

 
$
18,131

 
$
19,009

When foreclosure occurs, the acquired asset is recorded at fair value less selling costs, generally based on appraised value, which may result in partial charge-off of the loan. Subsequent write-downs required for declines in value are recorded through a valuation allowance or taken directly to the assets and charged to other non-interest expense.


18



(6) CERTAIN TRANSFERS OF FINANCIAL ASSETS
Through our Mortgage Correspondent Aggregation ("MCA") business, we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to Ginnie Mae and government sponsored entities ("GSEs") such as Fannie Mae and Freddie Mac. We have elected to carry these loans at fair value based on sales commitments and market quotes. Gains and losses on the sale of mortgage loans held for sale and changes in the fair value of the loans held for sale are included in other non-interest income on the consolidated income statement.
Residential mortgage loans held for sale are subject to both credit and interest rate risk. Credit risk is managed through underwriting policies and procedures, including collateral requirements, which are generally accepted by the secondary loan markets. Exposure to interest rate fluctuations is partially mitigated through forward sales contracts, which set the price for loans that will be delivered in the next 60 to 90 days.
The table below presents the unpaid principal balance of loans held for sale and related fair values at September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017
 
December 31, 2016
Outstanding balance
$
957,560

 
$
980,414

Fair value
955,983

 
968,929

Fair value over/(under) outstanding balance
$
(1,577
)
 
$
(11,485
)
No loans held for sale were 90 days or more past due or on non-accrual as of September 30, 2017 and December 31, 2016.
The table below presents a reconciliation of the changes in loans held for sale for the nine months ended September 30, 2017 and 2016 (in thousands):
 
Nine months ended September 30,
 
2017
 
2016
Beginning balance
$
968,929

 
$
86,075

Loans purchased
4,315,065

 
1,927,702

Payments and loans sold
(4,337,919
)
 
(1,368,987
)
Change in fair value
9,908

 
3,894

Ending balance
$
955,983

 
$
648,684

We generally retain the right to service the loans sold, creating MSRs which are recorded as assets on our balance sheet. A summary of MSR activity for the nine months ended September 30, 2017 and 2016 is as follows (in thousands):
 
Nine months ended September 30,
 
2017
 
2016
MSRs:
 
 
 
Balance, beginning of year(1)
$
28,536

 
$
423

    Capitalized servicing rights
54,614

 
16,344

    Amortization
(5,304
)
 
(891
)
Balance, end of period
$
77,846

 
$
15,876

Valuation allowance:
 
 
 
Balance, beginning of year
$

 
$

    Increase in valuation allowance
216

 
414

Balance, end of period
$
216

 
$
414

MSRs, net(1)
$
77,630

 
$
15,462

MSRs, fair value
$
78,940

 
$
15,970

(1)
MSRs are reported on the consolidated balance sheets at lower of amortized cost or market.
At September 30, 2017 and December 31, 2016, our servicing portfolio of residential mortgage loans had an outstanding principal balance of $6.1 billion and $2.2 billion, respectively. In connection with the servicing of these loans, we maintain

19



escrow funds for taxes and insurance in the name of investors, as well as collections in transit to investors. These escrow funds are segregated and held in separate non-interest-bearing accounts at the Bank. These deposits, included in total non-interest-bearing deposits on the consolidated balance sheets, were $81.4 million at September 30, 2017 and $21.0 million at December 31, 2016.
The estimated fair value of the MSR assets is obtained from an independent third party and reviewed by management on a quarterly basis. MSRs 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 collateral, where available. Each quarter, management and the independent third party discuss the key assumptions used in the discounted cash flow model and make adjustments as necessary to estimate the fair value of the MSRs. As of September 30, 2017 and December 31, 2016, management used the following assumptions to determine the fair value of MSRs:
 
September 30, 2017
December 31, 2016
Average discount rates
9.95
%
9.96
%
Expected prepayment speeds
9.79
%
7.91
%
Weighted average life, in years
7.1

8.0

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, 2017
 
December 31, 2016
50 bp adverse change in prepayment speed
$
(10,667
)
 
$
(2,833
)
100 bp adverse change in prepayment speed
(25,043
)
 
(6,812
)
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 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 lead to changes in other factors, which could impact the above hypothetical effects.
In conjunction with the sale and securitization of loans held for sale, we may be exposed to liability resulting from recourse agreements and repurchase agreements. If it is determined subsequent to our sale of a loan that the loan sold is in breach of the representations or warranties made in the applicable sale agreement, we may have an obligation to either (a) repurchase the loan for the unpaid principal balance, accrued interest and related advances, (b) indemnify the purchaser against any loss it suffers or (c) make the purchaser whole for the economic benefits of the loan.
Our repurchase, indemnification and make whole obligations vary based upon the terms of the applicable agreements, the nature of the asserted breach and the status of the mortgage loan at the time a claim is made. We establish reserves for estimated losses of this nature inherent in the origination of mortgage loans by estimating the losses inherent in the population of all loans sold based on trends in claims and actual loss severities experienced. The reserve includes accruals for probable contingent losses in addition to those identified in the pipeline of claims received. The estimation process is designed to include amounts based on any actual losses experienced from actual repurchase activity.
Because the MCA business commenced in late 2015, we have limited historical data to support the establishment of a reserve. The baseline for the repurchase reserve uses historical loss factors obtained from industry data that are applied to loan pools originated and sold during the nine months ended September 30, 2017 and 2016. The historical industry data loss factors and experienced losses are accumulated for each sale vintage and applied to more recent sale vintages to estimate inherent losses not yet realized. Our estimated exposure related to these loans was $1.2 million at September 30, 2017 and $621,000 at September 30, 2016 and is recorded in other liabilities in the consolidated balance sheets. We had $14,000 in losses due to repurchase, indemnification or make-whole obligations during the nine months ended September 30, 2017 and no losses during the nine months ended 2016.

20



(7) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit that involve varying degrees of credit risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the borrower.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit-worthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
The table below summarizes our off-balance sheet financial instruments whose contract amounts represented credit risk (in thousands):
 
 
September 30, 2017
 
December 31, 2016
Commitments to extend credit
$
6,539,498

 
$
5,704,381

Standby letters of credit
203,070

 
171,266

(8) REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material 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) establish the capital measure called "Common Equity Tier 1" ("CET1"), (ii) specify that Tier 1 capital consist of CET1 and "Additional Tier 1 Capital" instruments meeting stated requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) set forth the acceptable scope of deductions/adjustments to the specified capital measures. The Basel III Capital Rules became effective for us on January 1, 2015 with certain transition provisions fully phased in on January 1, 2019.
Additionally, the Basel III Capital Rules require that we maintain a capital conservation buffer with respect to each of the CET1, Tier 1 and total capital to risk-weighted assets, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. The capital conservation buffer is subject to a three year phase-in period that began on January 1, 2016 and will be fully phased in on January 1, 2019 at 2.5%. The required phase-in capital conservation buffer during 2017 is 1.25% and was 0.625% during 2016. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers.
Quantitative measures established by these regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of CET1, Tier 1 and total capital to risk-weighted assets, and of Tier 1 capital to average assets, each as defined in the regulations. Management believes, as of September 30, 2017, that the Company and the Bank met all capital adequacy requirements to which they are subject.
Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based capital, Tier 1 risk-based capital, 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, 2017 and December 31, 2016. Based upon the

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information in its most recently filed call report, the Bank met the capital ratios necessary to be well capitalized. The regulatory authorities can apply changes in classification of assets and such changes may retroactively subject the Company to changes in capital ratios. Any such changes could result in reducing one or more capital ratios below well-capitalized status. In addition, a change may result in imposition of additional assessments by the FDIC or could result in regulatory actions that could have a material adverse effect on our financial condition and results of operations.
Because our Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, we are allowed to continue to classify our trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital.
The table below summarizes our actual and required capital ratios under the Basel III Capital Rules: 
 
 
Actual
 
Minimum Capital Required - Basel III Phase-In Schedule
 
Minimum capital Required - Basel III Fully Phased-In
 
Required to be Considered Well Capitalized
 
 
Capital Amount
Ratio
 
Capital Amount
Ratio
 
Capital Amount
Ratio
 
Capital Amount
Ratio
As of September 30, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
CET1
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
$
1,989,547

8.35
%
 
$
1,369,699

5.75
%
 
$
1,667,460

7.00
%
 
N/A

N/A

    Bank
 
1,930,836

8.11
%
 
1,369,659

5.75
%
 
1,667,411

7.00
%
 
1,548,311

6.50
%
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,722,408

11.43
%
 
2,203,429

9.25
%
 
2,501,189

10.50
%
 
N/A

N/A

    Bank
 
2,505,209

10.52
%
 
2,203,365

9.25
%
 
2,501,117

10.50
%
 
2,382,016

10.00
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,248,403

9.44
%
 
1,727,012

7.25
%
 
2,024,772

8.50
%
 
N/A

N/A

    Bank
 
2,089,692

8.77
%
 
1,726,962

7.25
%
 
2,024,714

8.50
%
 
1,905,613

8.00
%
Tier 1 capital (to average assets)(1)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,248,403

9.57
%
 
939,319

4.00
%
 
939,319

4.00
%
 
N/A

N/A

    Bank
 
2,089,692

8.90
%
 
939,139

4.00
%
 
939,139

4.00
%
 
1,173,924

5.00
%
As of December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
CET1
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
$
1,841,219

8.97
%
 
$
1,052,205

5.13
%
 
$
1,437,159

7.00
%
 
N/A

N/A

    Bank
 
1,735,496

8.45
%
 
1,051,989

5.13
%
 
1,436,863

7.00
%
 
1,334,244

6.50
%
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,561,663

12.48
%
 
1,770,766

8.63
%
 
2,155,715

10.50
%
 
N/A

N/A

    Bank
 
2,297,528

11.19
%
 
1,770,421

8.63
%
 
2,155,295

10.50
%
 
2,052,683

10.00
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,101,071

10.23
%
 
1,360,154

6.63
%
 
1,745,103

8.50
%
 
N/A

N/A

    Bank
 
1,895,348

9.23
%
 
1,359,888

6.63
%
 
1,744,762

8.50
%
 
1,642,147

8.00
%
Tier 1 capital (to average assets)(1)
 
 
 
 
 
 
 
 
 
 
 
 
    Company
 
2,101,071

9.34
%
 
900,268

4.00
%
 
900,268

4.00
%
 
N/A

N/A

    Bank
 
1,895,348

8.42
%
 
900,070

4.00
%
 
900,070

4.00
%
 
1,125,087

5.00
%
(1)
The Tier 1 capital ratio (to average assets) is not impacted by the Basel III Capital Rules; however, it should be noted that the Federal Reserve Board and the FDIC may require the Company and the Bank, respectively, to maintain a Tier 1 capital ratio (to average assets) above the required minimum.
Our mortgage finance loan volumes can increase significantly at month end, causing a meaningful difference between ending balance and average balance for any period. At September 30, 2017, our total mortgage finance loans were $5.6 billion compared to the average for the three months ended September 30, 2017 of $4.8 billion. As CET1, Tier 1 and total capital ratios are calculated using quarter-end risk-weighted assets and our mortgage finance loans are 100% risk-weighted, the quarter-end fluctuation in these balances can significantly impact our reported ratios. We manage capital allocated to mortgage finance

22

Table of Contents

loans based on changing trends in average balances, as well as the inherent risk associated with the assets which implies a risk weight that is significantly different than the regulatory risk weight, and do not believe that the quarter-end balance is representative of risk characteristics that would justify higher capital allocations. However, we continue to monitor our capital allocation to confirm that all capital levels remain above well-capitalized levels.
Dividends that may be paid by subsidiary banks are routinely restricted by various regulatory authorities. The amount that can be paid in any calendar year without prior approval of the Bank’s regulatory agencies cannot exceed the lesser of the net profits (as defined) for that year plus the net profits for the preceding two calendar years, or retained earnings. The Basel III Capital Rules further limit the amount of dividends that may be paid by our Bank. No dividends were declared or paid on common stock during the nine months ended September 30, 2017 or 2016.
(9) STOCK-BASED COMPENSATION
We have long-term incentive plans under which stock-based compensation awards are granted to employees and directors by the board of directors, or its designated committee. Grants are subject to vesting requirements and may include, among other things, nonqualified stock options, stock appreciation rights ("SARs"), restricted stock units ("RSUs"), restricted stock and performance units, or any combination thereof. There are 2,550,000 total shares authorized under the plans.
Stock-based compensation expense presented below consists of awards granted from 2011 through September 30, 2017.
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Stock-settled awards:
 
 
 
 
 
 
 
SARs
$
64

 
$
74

 
$
210

 
$
233

RSUs
2,184

 
1,145

 
5,491

 
3,223

Restricted stock
8

 
4

 
16

 
10

Cash-settled performance units
3,811

 
1,227

 
9,304

 
2,709

Total
$
6,067

 
$
2,450

 
$
15,021

 
$
6,175

 
(in thousands)
September 30, 2017
Unrecognized compensation expense related to unvested stock-settled awards
$
19,426

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


(10) FAIR VALUE DISCLOSURES
ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value, establishes a framework for measuring fair value under GAAP and requires enhanced disclosures about fair value measurements. Fair value is defined under ASC 820 as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal market for the asset or liability in an orderly transaction between market participants on the measurement date.
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. This category includes the assets and liabilities related to our non-qualified deferred compensation plan where values are based on quoted market prices for identical equity securities in an active market.
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets include U.S. government and agency mortgage-backed debt securities, municipal bonds, and Community Reinvestment Act funds. This category also includes loans held for sale and derivative assets and liabilities where values are obtained from independent pricing services using observable market data.

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Table of Contents

Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair values requires significant management judgment or estimation. This category includes impaired loans and OREO where collateral values have been based on third party appraisals; comparative sales data typically used in appraisals may be unavailable or more subjective with respect to some asset classes due to lack of market activity.

Assets and liabilities measured at fair value at September 30, 2017 and December 31, 2016 are as follows (in thousands):
 
Fair Value Measurements Using
September 30, 2017
Level 1
 
Level 2
 
Level 3
Available-for-sale securities:(1)
 
 
 
 
 
Residential mortgage-backed securities
$

 
$
12,158

 
$

Equity securities(2)
4,905

 
7,161

 

Loans held for sale (3)

 
955,983

 

Loans held for investment(4) (6)

 

 
21,022

OREO(5) (6)

 

 
18,131

Derivative assets(7)

 
25,130

 

Derivative liabilities(7)

 
24,048

 

Non-qualified deferred compensation plan liabilities (8)
4,961

 

 

 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
Available-for-sale securities:(1)
 
 
 
 
 
Residential mortgage-backed securities
$

 
$
15,652

 
$

Municipals

 
275

 

Equity securities(2)
1,786

 
7,161

 

Loans held for sale(3)

 
968,929

 

Loans held for investment(4) (6)

 

 
52,323

OREO(5) (6)

 

 
18,961

Derivative assets(7)

 
37,878

 

Derivative liabilities(7)

 
26,240

 

Non-qualified deferred compensation plan liabilities (8)
1,811

 

 

 
(1)
Securities are measured at fair value on a recurring basis, generally monthly.
(2)
Equity securities consist of Community Reinvestment Act funds and investments related to our non-qualified deferred compensation plan.
(3)
Loans held for sale, excluding Small Business Administration loans, 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 corresponds to the fair value of the invested assets, and are measured at fair value on a recurring basis, generally monthly.

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Table of Contents

Level 3 Valuations
Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments include those for which the determination of fair value requires significant management judgment or estimation. Currently, we measure the fair value for certain collateral dependent impaired loans and OREO on a nonrecurring basis as described below.
Loans held for investment
At September 30, 2017 and December 31, 2016, certain impaired loans held for investment were reported at fair value through a specific allocation of the allowance for loan losses based upon the fair value of the underlying collateral. The $21.0 million fair value of loans held for investment at September 30, 2017 reported above includes impaired loans held for investment with a carrying value of $28.3 million that were reduced by specific allowance allocations totaling $7.3 million based on collateral valuations utilizing Level 3 valuation inputs. The $52.3 million fair value of loans held for investment at December 31, 2016 reported above includes impaired loans with a carrying value of $74.1 million that were reduced by specific valuation allowance allocations totaling $21.8 million based on collateral valuations utilizing Level 3 valuation inputs. Fair values were based on third party appraisals.
OREO
Certain foreclosed assets, upon initial recognition, are recorded at fair value less estimated selling costs. At September 30, 2017 and December 31, 2016, OREO had a carrying value of $18.1 million million and $19.0 million, respectively, with a valuation allowance of $101,000 at September 30, 2017 and none at December 31, 2016. The fair value of OREO was computed based on third party appraisals, which are Level 3 valuation 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.

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Table of Contents

A summary of the carrying amounts and estimated fair values of financial instruments is as follows (in thousands):
 
 
September 30, 2017
 
December 31, 2016
  
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial assets:
 
 
 
 
 
 
 
   Level 1 inputs:
 
 
 
 
 
 
 
Cash and cash equivalents
$
2,501,153

 
$
2,501,153

 
$
2,839,352

 
$
2,839,352

Securities, available-for-sale
4,905

 
4,905

 
1,786

 
1,786

   Level 2 inputs:
 
 
 
 
 
 
 
Securities, available-for-sale
19,319

 
19,319

 
23,088

 
23,088

Loans held for sale
955,983

 
955,983

 
968,929

 
968,929

Derivative assets
25,130

 
25,130

 
37,878

 
37,878

   Level 3 inputs:
 
 
 
 
 
 
 
Loans held for investment, net
20,287,762

 
20,274,939

 
17,330,223

 
17,347,199

Financial liabilities:
 
 
 
 
 
 
 
   Level 2 inputs:
 
 
 
 
 
 
 
Federal funds purchased
75,800

 
75,800

 
101,800

 
101,800

Customer repurchase agreements
7,696

 
7,696

 
7,775

 
7,775

Other borrowings
2,500,000

 
2,500,000

 
2,000,000

 
2,000,000

Subordinated notes
281,315

 
287,686

 
281,044

 
304,672

Derivative liabilities
24,048

 
24,048

 
26,240

 
26,240

   Level 3 inputs:
 
 
 
 
 
 
 
Deposits
19,081,257

 
19,081,954

 
17,016,831

 
17,017,221

Trust preferred subordinated debentures
113,406

 
113,406

 
113,406

 
113,406

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents approximate their fair value, and these financial instruments are characterized as Level 1 assets in the fair value hierarchy.
Securities available-for-sale
Within the securities available-for-sale portfolio, we hold equity securities related to our non-qualified deferred compensation plan which are valued using quoted market prices for identical equity securities in an active market. These financial instruments are classified as Level 1 assets in the fair value hierarchy. The fair value of the remaining investment portfolio is based on prices obtained from independent pricing services which are based on quoted market prices for the same or similar securities, and these financial instruments are characterized as Level 2 assets in the fair value hierarchy. We have obtained documentation from the primary pricing service we use about their processes and controls over pricing. In addition, on a quarterly basis we independently verify the prices that we receive from the service provider using two additional independent pricing sources. Any significant differences are investigated and resolved.
Loans held for sale
Fair value for loans held for sale is derived from quoted market prices for similar loans, and these financial instruments are characterized as Level 2 assets in the fair value hierarchy.
Loans held for investment, net
Loans held for investment are characterized as Level 3 assets in the fair value hierarchy. For variable-rate loans held for investment that reprice frequently with no significant change in credit risk, fair values are generally based on carrying values. The fair value for all other loans held for investment is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximates its fair value.

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Derivatives
The estimated fair value of the interest rate swaps and caps is obtained from independent pricing services based on quoted market prices for similar derivative contracts and these financial instruments are characterized as Level 2 assets and liabilities in the fair value hierarchy. On a quarterly basis, we independently verify the fair value using an additional independent pricing source. Any significant differences are investigated and resolved. 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 the quoted market prices from brokers. As such, these loan purchase commitments and forward sales commitments are classified as Level 2 assets or liabilities in the fair value hierarchy.
Deposits
Deposits are characterized as Level 3 liabilities in the fair value hierarchy. The carrying amounts for variable-rate money market accounts approximate their fair value. The fair values of fixed-term certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities.
Federal funds purchased, customer repurchase agreements, other borrowings, subordinated notes and trust preferred subordinated debentures
The carrying value reported in the consolidated balance sheets for Federal funds purchased, customer repurchase agreements and other short-term, floating rate borrowings approximates their fair value, and these financial instruments are characterized as Level 2 liabilities in the fair value hierarchy. The fair value of any fixed rate short-term borrowings and trust preferred subordinated debentures are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar borrowings, and these financial instruments are characterized as Level 3 liabilities in the fair value hierarchy. The subordinated notes are publicly, though infrequently, traded, are valued based on market prices and are characterized as Level 2 liabilities in the fair value hierarchy.
(11) DERIVATIVE FINANCIAL INSTRUMENTS
The fair value of derivative positions outstanding is included in accrued interest receivable and other assets and other liabilities in the accompanying consolidated balance sheets on a net basis when a right of offset exists, based on transactions with a single counterparty that are subject to a legally enforceable master netting agreement.
During the three and nine months ended September 30, 2017 and 2016, we entered into certain interest rate derivative positions that were not designated as hedging instruments. These derivative positions relate to transactions in which we enter into an interest rate swap, cap and/or floor with a customer while at the same time entering into an offsetting interest rate swap, cap and/or floor with another financial institution. In connection with each swap transaction, we agree to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows our customer to effectively convert a variable rate loan to a fixed rate. Because we act as an intermediary for our customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on our results of operations.
During the three and nine months ended September 30, 2017 and 2016, we entered into loan purchase commitment contracts with mortgage originators to purchase residential mortgage loans at a future date, as well as forward sales commitment contracts to sell residential mortgage loans at a future date.

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The notional amounts and estimated fair values of interest rate derivative positions outstanding at September 30, 2017 and December 31, 2016 are presented in the following tables (in thousands):
 
 
September 30, 2017
 
December 31, 2016
 
Estimated Fair Value
 
Estimated Fair Value
 
Notional
Amount
 
Asset Derivative
 
Liability Derivative
 
Notional
Amount
 
Asset Derivative
 
Liability Derivative
Non-hedging interest rate derivatives:
 
 
 
 
 
 
 
 
 
 
 
Financial institution counterparties:
 
 
 
 
 
 
 
 
 
 
 
Commercial loan/lease interest rate swaps
$
1,376,915

 
$
1,650

 
$
23,390

 
$
1,144,367

 
$
1,754

 
$
25,421

Commercial loan/lease interest rate caps
267,765

 
295

 
1

 
210,996

 
819

 

Customer counterparties:
 
 
 
 
 
 
 
 
 
 
 
Commercial loan/lease interest rate swaps
1,376,915

 
23,390

 
1,650

 
1,144,367

 
25,421

 
1,754

Commercial loan/lease interest rate caps
267,765

 
1

 
295

 
210,996

 

 
819

Economic hedging interest rate derivatives:
 
 
 
 
 
 
 
 
 
 
 
Loan purchase commitments
168,784

 
279

 
363

 
237,805

 
1,351

 

Forward sales commitments
1,022,613

 
1,166

 

 
1,218,000

 
10,287

 

Gross derivatives
 
 
26,781

 
25,699

 
 
 
39,632

 
27,994

Offsetting derivative assets/liabilities
 
 
(1,651
)
 
(1,651
)
 
 
 
(1,754
)
 
(1,754
)
Net derivatives included in the consolidated balance sheets
 
 
$
25,130

 
$
24,048

 
 
 
$
37,878

 
$
26,240

The weighted average received and paid interest rates for interest rate swaps outstanding at September 30, 2017 and December 31, 2016 were as follows:
 
 
September 30, 2017
Weighted Average Interest Rate
 
December 31, 2016
Weighted Average Interest Rate
 
Received
 
Paid
 
Received
 
Paid
Non-hedging interest rate swaps
3.46
%
 
4.43
%
 
3.17
%
 
4.58
%
The weighted average strike rate for outstanding interest rate caps was 2.50% at September 30, 2017 and 2.45% at December 31, 2016.
Our credit exposure on derivative instruments is limited to the net favorable value and interest payments by each counterparty. In such cases collateral may be required from the counterparties involved if the net value of the derivative instruments exceed a nominal amount considered to be immaterial. Our credit exposure, net of any collateral pledged, was approximately $25.1 million at September 30, 2017 and approximately $37.9 million at December 31, 2016, which primarily relates to Bank customers. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. At September 30, 2017, we had $35.1 million in cash collateral pledged for these derivatives, of which $28.0 million was included in interest-bearing deposits and $7.1 million was included in accrued interest receivable and other assets. At December 31, 2016, we had $24.8 million in cash collateral pledged for these derivatives, all of which was included in interest-bearing deposits.

28



(12) NEW ACCOUNTING PRONOUNCEMENTS
ASU 2017-09 "Compensation-Stock Compensation (Topic 718)-Scope of Modification Accounting" ("ASU 2017-09") clarifies when changes to the terms or conditions of a share-based payment must be accounted for as modifications. Under ASU 2017-09, an entity should account for changes to the terms or conditions of a share-based payment as a modification unless all of the following are met: 1)the fair value of the modified award is the same as the fair value of the original award immediately before modification, 2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before modification, and 3) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before modification. ASU 2017-09 will be effective for us on January 1, 2018, and is not expected to have a significant impact on our financial statements.
ASU 2016-15 "Statement of Cash Flows (Topic 230)" ("ASU 2016-15") is intended to reduce the diversity in practice around how certain transactions are classified within the statement of cash flows. ASU 2016-15 will be effective for us on January 1, 2018 and is not expected to have a significant 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 are evaluating the impact adoption of ASU 2016-13 will have on our consolidated financial statements and disclosures.
ASU 2016-02 "Leases (Topic 842)" ("ASU 2016-02") requires that lessees and lessors recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. ASU 2016-02 will be effective for us on January 1, 2019. We have not yet selected a transition method as we are in the process of determining the effect of the standard on our consolidated financial statements and disclosures.
ASU 2014-09 "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09") implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 establishes a five-step model which entities must follow to recognize revenue and removes inconsistencies and weaknesses in existing guidance. The guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, which comprises a significant portion of our revenue stream. Adoption of ASU 2014-09 may require us to amend how we recognize certain recurring revenue streams related to trust fees, which are recorded in non-interest income; however, we do not expect adoption of ASU 2014-09 to have a material impact on our consolidated financial statements and disclosures. We plan to adopt the revenue recognition guidance in the first quarter of 2018 with a cumulative effect adjustment to opening retained earnings, if management deems such adjustment significant. Our implementation efforts to date include identification of revenue streams within the scope of the guidance, and we are in the process of reviewing revenue contracts.

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Table of Contents

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

 
For the three months ended 
 September 30, 2017
 
For the three months ended 
 September 30, 2016
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Securities – taxable
$
86,087

 
$
340

 
1.57
%
 
$
26,051

 
$
228

 
3.47
%
Securities – non-taxable(2)

 

 
%
 
564

 
8

 
5.82
%
Federal funds sold and securities purchased under resale agreements
205,938

 
642

 
1.24
%
 
369,215

 
455

 
0.49
%
Deposits in other banks
2,383,060

 
7,544

 
1.26
%
 
3,192,141

 
4,080

 
0.51
%
Loans held for sale
1,009,703

 
9,882

 
3.88
%
 
430,869

 
3,662

 
3.38
%
Loans held for investment, mortgage finance
4,847,530

 
42,294

 
3.46
%
 
4,658,804

 
36,655

 
3.13
%
Loans held for investment(1)(2)
14,427,980

 
178,839

 
4.92
%
 
12,591,561

 
137,407

 
4.34
%
Less reserve for loan losses
172,774

 

 

 
168,086

 

 

Loans held for investment, net
19,102,736

 
221,133

 
4.59
%
 
17,082,279

 
174,062

 
4.05
%
Total earning assets
22,787,524

 
239,541

 
4.17
%
 
21,101,119

 
182,495

 
3.44
%
Cash and other assets
713,778

 
 
 
 
 
588,440

 
 
 
 
Total assets
$
23,501,302

 
 
 
 
 
$
21,689,559

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
$
2,145,324

 
$
4,359

 
0.81
%
 
$
2,301,362

 
$
1,960

 
0.34
%
Savings deposits
7,618,843

 
17,152

 
0.89
%
 
6,177,681

 
6,228

 
0.40
%
Time deposits
496,076

 
924

 
0.74
%
 
501,701

 
763

 
0.61
%
Total interest-bearing deposits
10,260,243

 
22,435

 
0.87
%
 
8,980,744

 
8,951

 
0.40
%
Other borrowings
1,821,837

 
5,726

 
1.25
%
 
1,607,613

 
1,860

 
0.46
%
Subordinated notes
281,256

 
4,191

 
5.91
%
 
280,895

 
4,191

 
5.94
%
Trust preferred subordinated debentures
113,406

 
930

 
3.25
%
 
113,406

 
752

 
2.64
%
Total interest-bearing liabilities
12,476,742

 
33,282

 
1.06
%
 
10,982,658

 
15,754

 
0.57
%
Demand deposits
8,764,263

 
 
 
 
 
8,849,725

 
 
 
 
Other liabilities
116,998

 
 
 
 
 
135,141

 
 
 
 
Stockholders’ equity
2,143,299

 
 
 
 
 
1,722,035

 
 
 
 
Total liabilities and stockholders’ equity
$
23,501,302

 
 
 
 
 
$
21,689,559

 
 
 
 
Net interest income(2)
 
 
$
206,259

 
 
 
 
 
$
166,741

 
 
Net interest margin
 
 
 
 
3.59
%
 
 
 
 
 
3.14
%
Net interest spread
 
 
 
 
3.11
%
 
 
 
 
 
2.87
%
Loan spread(3)
 
 
 
 
4.02
%
 
 
 
 
 
3.83
%
 
(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.







 
For the nine months ended September 30, 2017
 
For the nine months ended September 30, 2016
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Securities – taxable
$
61,212

 
$
851

 
1.86
%
 
$
27,160

 
$
722

 
3.55
%
Securities – non-taxable(2)
74

 
3

 
4.85
%
 
629

 
27

 
5.74
%
Federal funds sold and securities purchased under resale agreements
218,777

 
1,606

 
0.98
%
 
328,971

 
1,209

 
0.49
%
Deposits in other banks
2,645,145

 
19,935

 
1.01
%
 
2,905,251

 
11,115

 
0.51
%
Loans held for sale
973,016

 
27,652

 
3.80
%
 
238,987

 
6,106

 
3.41
%
Loans held for investment, mortgage finance
3,811,298

 
98,798

 
3.47
%
 
4,266,573

 
99,666

 
3.12
%
Loans held for investment(1)(2)
13,714,390

 
485,226

 
4.73
%
 
12,260,752

 
395,901

 
4.31
%
Less reserve for loan losses
171,029

 

 

 
157,880

 

 

Loans held for investment, net
17,354,659

 
584,024

 
4.50
%
 
16,369,445

 
495,567

 
4.04
%
Total earning assets
21,252,883

 
634,071

 
3.99
%
 
19,870,443

 
514,746

 
3.46
%
Cash and other assets
651,270

 
 
 
 
 
546,553

 
 
 
 
Total assets
$
21,904,153

 
 
 
 
 
$
20,416,996

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
$
2,054,701

 
$
9,445

 
0.61
%
 
$
2,171,776

 
$
5,085

 
0.31
%
Savings deposits
7,189,274

 
40,575

 
0.75
%
 
6,299,965

 
19,441

 
0.41
%
Time deposits
460,046

 
2,241

 
0.65
%
 
499,366

 
2,217

 
0.59
%
Total interest-bearing deposits
9,704,021

 
52,261

 
0.72
%
 
8,971,107

 
26,743

 
0.40
%
Other borrowings
1,539,208

 
11,626

 
1.01
%
 
1,455,888

 
4,628

 
0.25
%
Subordinated notes
281,167

 
12,573

 
5.98
%
 
280,805

 
12,573

 
5.98
%
Trust preferred subordinated debentures
113,406

 
2,641

 
3.11
%
 
113,406

 
2,203

 
2.59
%
Total interest-bearing liabilities
11,637,802

 
79,101

 
0.91
%
 
10,821,206

 
46,147

 
0.55
%
Demand deposits
8,062,792

 
 
 
 
 
7,786,562

 
 
 
 
Other liabilities
112,505

 
 
 
 
 
132,506

 
 
 
 
Stockholders’ equity
2,091,054

 
 
 
 
 
1,676,722

 
 
 
 
Total liabilities and stockholders’ equity
$
21,904,153

 
 
 
 
 
$
20,416,996

 
 
 
 
Net interest income(2)
 
 
$
554,970

 
 
 
 
 
$
468,599

 
 
Net interest margin
 
 
 
 
3.49
%
 
 
 
 
 
3.15
%
Net interest spread
 
 
 
 
3.08
%
 
 
 
 
 
2.91
%
Loan spread(3)
 
 
 
 
4.02
%
 
 
 
 
 
3.82
%

(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

ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Certain statements and financial analysis contained in this report that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of federal securities laws. Forward-looking statements may also be contained in our future filings with SEC, in press releases and in oral and written statements made by us or with our approval that are not statements of historical fact. These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. Words such as “believes,” “expects,” “estimates,” “anticipates,” “plans,” “goals,” “objectives,” “expects,” “intends,” “seeks,” “likely,” “targeted,” “continue,” “remain,” “will,” “should,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements may include, among other things, statements about the credit quality of our loan portfolio, economic conditions, including the continued impact on our customers from declines and volatility in oil and gas prices, the impact on our loan and deposit portfolios as a result of Hurricanes Harvey and Irma, expectations regarding rates of default or loan losses, volatility in the mortgage industry, our business strategies and our expectations about future financial performance, future growth and earnings, the appropriateness of our allowance for loan losses and provision for credit losses, the impact of increased regulatory requirements on our business, increased competition, interest rate risk, new lines of business, new product or service offerings and new technologies.
Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management’s expectations and assumptions at the time the statements are made and are not guarantees of future results. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, the following:
Deterioration of the credit quality of our loan portfolio or declines in the value of collateral related to external factors such as commodity prices, real estate values or interest rates, increased default rates and loan losses or adverse changes in the industry concentrations of our loan portfolio.
Changing economic conditions or other developments adversely affecting our commercial, entrepreneurial and professional customers.
Changes in the value of commercial and residential real estate securing our loans or in the demand for credit to support the purchase and ownership of such assets.
The failure to correctly assess and model the assumptions supporting our allowance for loan losses, causing it to become inadequate in the event of deteriorations in loan quality and increases in charge-offs.
Changes in the U.S. economy in general or the Texas economy specifically resulting in deterioration of credit quality, increases in non-performing assets or charge-offs or reduced demand for credit or other financial services we offer, including the effects from declines in the level of drilling and production related to the continued volatility in oil and gas prices.
Adverse changes in economic or market conditions, or our operating performance, which 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 our information systems risk or to prevent cyber-attacks against us or our third party vendors, or to manage risks from disruptions or security breaches affecting our third party vendors.
The failure to effectively manage our interest rate risk resulting from unexpectedly large or sudden changes in interest rates or rate or maturity imbalances in our assets and liabilities, and potential adverse effects to our borrowers including their inability to repay loans with increased interest rates.
Legislative and regulatory changes imposing further restrictions and costs on our business, a failure to remain well capitalized or well managed status or regulatory enforcement actions against us, and uncertainty related to future implementation and enforcement of regulatory requirements resulting from the current political environment.

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Table of Contents

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.
Adverse changes in economic or business conditions that impact the financial markets or our customers.
Structural changes in the markets for origination, sale and servicing of residential mortgages.
Increased or more effective competition from banks and other financial service providers in our markets.
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 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 2016 Form 10-K and other filings we have made with the SEC. Though we strive to monitor and mitigate risk, we cannot anticipate all potential economic, operational and financial developments that may adversely impact our operations and our financial results. Forward-looking statements should not be viewed as predictions and should not be the primary basis upon which investors evaluate an investment in our securities.
Overview of Our Business Operations
We commenced our banking operations in December 1998. An important aspect of our growth strategy has been our ability to service and manage effectively a large number of loans and deposit accounts in multiple markets in Texas, as well as several lines of business serving a regional or national clientele of commercial borrowers. Accordingly, we have created an operations infrastructure sufficient to support our lending and banking operations that we continue to build out as needed to serve a larger customer base and specialized industries.
Outstanding energy loans totaled $1.2 billion, or approximately 6% of total loans, at September 30, 2017. Unfunded energy loan commitments increased by $93.5 million to $624.3 million (51% of outstanding energy loans) at September 30, 2017 compared to $530.8 million at December 31, 2016. We recorded $19.8 million in energy net charge-offs during the nine months ended September 30, 2017 compared to $19.8 million for the same period in 2016. Energy non-accruals decreased to $81.6 million at September 30, 2017 compared to $82.6 million at June 30, 2017 and $129.3 million at September 30, 2016. We continue to proactively manage our energy portfolio and overall credit quality, and we believe we are appropriately reserved against further energy-related losses.

32



The following discussion and analysis presents the significant factors affecting our financial condition as of September 30, 2017 and December 31, 2016 and results of operations for the three and nine months in the periods ended September 30, 2017 and 2016. This discussion should be read in conjunction with our consolidated financial statements and notes to the financial statements appearing in Part I, Item 1 of this report.
Results of Operations
Summary of Performance
We reported net income of $58.7 million and net income available to common stockholders of $56.2 million, or $1.12 per diluted common share, for the third quarter of 2017 compared to net income of $42.7 million and net income available to common stockholders of $40.3 million, or $0.87 per diluted common share, for the third quarter of 2016. Return on average common equity (“ROE”) was 11.20% and return on average assets ("ROA") was 0.99% for the third quarter of 2017, compared to 10.20% and 0.78%, respectively, for the third quarter of 2016. The increase in ROE and ROA for the quarter resulted from increases in net interest income and non-interest income and a decrease in the provision for credit losses that exceeded growth in non-interest expense. ROA also benefited from more effective utilization of liquidity balances as balances were deployed into higher yielding loan categories.
Net income and net income available to common stockholders for the nine months ended September 30, 2017 totaled $152.3 million and $145.0 million, respectively, or $2.89 per diluted common share, compared to net income and net income available to common stockholders of $106.7 million and $99.4 million, respectively, or $2.14 per diluted common share, for the same period in 2016. ROE was 9.99% and ROA was 0.93% for the nine months ended September 30, 2017 compared to 8.70% and 0.70%, respectively, for the nine months ended September 30, 2016. The increase in ROE and ROA for the first nine months of 2017 resulted from increases in net interest income and non-interest income and a decrease in the provision for credit losses that exceeded growth in non-interest expense. ROA also benefited from more effective utilization of liquidity balances and an increase in net interest margin.
Net income increased $16.0 million, or 37%, for the three months ended September 30, 2017, as compared to the same period in 2016. The increase was primarily the result of a $37.6 million increase in net interest income, a $2.0 million decrease in the provision for credit losses and a $2.3 million increase in non-interest income, offset by a $20.0 million increase in non-interest expense and a $5.9 million increase in income tax expense. Net income increased $45.6 million, or 43%, for the nine months ended September 30, 2017, as compared to the same period in 2016. The increase was primarily the result of an $82.1 million increase in net interest income, a $26.0 million decrease in the provision for credit losses and a $12.9 million increase in non-interest income, offset by a $56.9 million increase in non-interest expense and a $18.6 million increase in income tax expense.
Details of the changes in the various components of net income are discussed below.

Net Interest Income
Net interest income was $204.4 million for the third quarter of 2017, compared to $166.7 million for the third quarter of 2016. The increase was due to an increase in average earning assets of $1.7 billion as compared to the third quarter of 2016, as well as the effect of increases in interest rates on loan yields. The increase in average earning assets included a $578.8 million increase in average loans held for sale, a $2.0 billion increase in average net loans held for investment and a $59.5 million increase in average securities, offset by a $972.4 million decrease in average liquidity assets. For the quarter ended September 30, 2017, average net loans held for investment, liquidity assets and loans held for sale represented approximately 84%, 11% and 5%, respectively, of average earning assets compared to approximately 81%, 17% and 2% for the same quarter of 2016.
Average interest-bearing liabilities for the quarter ended September 30, 2017 increased $1.5 billion from the third quarter of 2016, which included a $1.3 billion increase in average interest-bearing deposits and a $214.2 million increase in other borrowings. Average demand deposits were $8.8 billion for the quarter ended September 30, 2016, compared to $8.8 billion for the same period at 2017. The average cost of total deposits and borrowed funds increased to 0.54% for the third quarter of 2017 compared to 0.22% for the same period of 2016. The cost of interest-bearing liabilities increased from 0.57% for the quarter ended September 30, 2016 to 1.06% for the same period of 2017.

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Net interest income was $550.7 million for the nine months ended September 30, 2017, compared to $468.6 million for the same period of 2016. The increase was due to an increase in average earning assets of $1.4 billion as compared to the nine months ended September 30, 2016, as well as the effect of increases in interest rates on loan yields. The increase in average earning assets included a $734.0 million increase in average loans held for sale, a $985.2 million increase in average net loans held for investment and a $33.5 million increase in average securities, offset by a $370.3 million decrease in average liquidity assets. For the nine months ended September 30, 2017, average net loans held for investment, liquidity assets and loans held for sale represented approximately 82%, 13% and 5%, respectively, of average earning assets compared to approximately 83%, 16% and 1% for the same period of 2016.
Average interest-bearing liabilities for the nine months ended September 30, 2017 increased $816.6 million from the same period of 2016, which included a $732.9 million increase in average interest-bearing deposits and a $83.3 million increase in other borrowings. Average demand deposits increased from $7.8 billion for the nine months ended September 30, 2016 to $8.1 billion for the nine months ended September 30, 2017. The average cost of total deposits and borrowed funds increased to 0.44% for the nine months ended September 30, 2017 compared to 0.23% for the same period of 2016. The cost of interest-bearing liabilities increased from 0.55% for the nine months ended September 30, 2016 to 0.91% for the same period of 2017.
The following table (in thousands) presents changes in taxable-equivalent net interest income between the three and nine month periods ended September 30, 2017 and September 30, 2016 and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and changes due to differences in the average interest rate on those assets and liabilities.
 
Three months ended
September 30, 2017/2016
 
Nine months ended
September 30, 2017/2016
 
Net
 
Change Due To(1)
 
Net
 
Change Due To(1)
 
Change
 
Volume
 
Yield/Rate
 
Change
 
Volume
 
Yield/Rate
Interest income:
 
 
 
 
 
 
 
 
 
 
 
Securities(2)
$
104

 
$
517

 
$
(413
)
 
$
105

 
$
888

 
$
(783
)
Loans held for sale
6,220

 
4,931

 
1,289

 
21,546

 
18,737

 
2,809

Loans held for investment, mortgage finance loans
5,639

 
1,489

 
4,150

 
(868
)
 
(10,625
)
 
9,757

Loans held for investment(2)
41,432

 
20,089

 
21,343

 
89,325

 
46,895

 
42,430

Federal funds sold
187

 
(202
)
 
389

 
397

 
(404
)
 
801

Deposits in other banks
3,464

 
(1,040
)
 
4,504

 
8,820

 
(994
)
 
9,814

Total
57,046

 
25,784

 
31,262

 
119,325

 
54,497

 
64,828

Interest expense:
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
2,399

 
(134
)
 
2,533

 
4,355

 
(274
)
 
4,629

Savings deposits
10,924

 
1,453

 
9,471

 
21,139

 
2,741

 
18,398

Time deposits
161

 
(9
)
 
170

 
23

 
(174
)
 
197

Borrowed funds
3,866

 
248

 
3,618

 
6,998

 
265

 
6,733

Long-term debt
178

 
5

 
173

 
439

 

 
439

Total
17,528

 
1,563

 
15,965

 
32,954

 
2,558

 
30,396

Net interest income
$
39,518

 
$
24,221

 
$
15,297

 
$
86,371

 
$
51,939

 
$
34,432

 
(1)
Yield/rate and volume variances are allocated to yield/rate.
(2)
Taxable equivalent rates are used where applicable and assume a 35% tax rate.
Net interest margin, which is defined as the ratio of net interest income to average earning assets, was 3.59% for the third quarter of 2017 compared to 3.14% for the third quarter of 2016. The year-over-year increase was primarily due to the effect of increases in interest rates on loan yields attributable to our highly asset-sensitive balance sheet. The yield on total loans held for investment increased to 4.59% for the third quarter of 2017 compared to 4.05% for the third quarter of 2016 and the yield on earning assets increased to 4.17% for the third quarter of 2017 compared to 3.44% for the third quarter of 2016. Funding costs, including demand deposits and borrowed funds, increased to 0.54% for the third quarter of 2017 compared to 0.22% for the third quarter of 2016. The spread on total earning assets, net of the cost of deposits and borrowed funds, was 3.63% for the third quarter of 2017 compared to 3.22% for the third quarter of 2016. The increase resulted primarily from increases in interest rates and increases in the higher yielding loan components of earning assets. Total funding costs, including all deposits, long-term debt and stockholders’ equity, increased to 0.56% for the third quarter of 2017 compared to .29% for the third quarter of 2016.

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Non-interest Income
The components of non-interest income were as follows (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Service charges on deposit accounts
$
3,211

 
$
2,880

 
$
9,323

 
$
7,401

Wealth management and trust fee income
1,627

 
1,113

 
4,386

 
3,024

Bank owned life insurance (BOLI) income
615

 
520

 
1,562

 
1,592

Brokered loan fees
6,152

 
7,581

 
17,639

 
18,090

Servicing income
4,486

 
310

 
10,387

 
305

Swap fees
647

 
918

 
3,404

 
2,330

Other
2,265

 
3,394

 
8,181

 
9,203

Total non-interest income
$
19,003

 
$
16,716

 
$
54,882

 
$
41,945

Non-interest income increased $2.3 million during the three months ended September 30, 2017 compared to the same period of 2016. This increase was primarily due to a $4.2 million increase in servicing income during the three months ended September 30, 2017 compared to the same period of 2016 primarily attributable to an increase in MSRs. Offsetting this increase was a $1.4 million decrease in brokered loan fees compared to the three months ended September 30, 2016 resulting from a decrease in total mortgage finance volumes.
Non-interest income increased $12.9 million during the nine months ended September 30, 2017 compared to the same period of 2016. This increase was primarily due to a $10.1 million increase in servicing income during the nine months ended September 30, 2017 compared to the same period of 2016 primarily attributable to an increase in MSRs. Service charges increased $1.9 million during the nine months ended September 30, 2017 compared to the same period of 2016 as a result of the increase in deposit balances and improved pricing of treasury services. Wealth management and trust fee income increased $1.4 million during the nine months ended September 30, 2017 compared to the same period of 2016 due to an increase in assets under management. Swap fees increased $1.1 million during the nine months ended September 30, 2017 compared to the same period of 2016. Swap fees relate to customer swap transactions and are received from the institution that is our counterparty on the transaction. These fees fluctuate from quarter to quarter based on the volume and size of transactions closed during the quarter. These increases were offset by minor decreases in brokered loan fees, BOLI income and other non-interest income compared to the same period of 2016.
While management expects continued growth in certain components of non-interest income, the future rate of growth could be affected by increased competition from nationwide and regional financial institutions among other factors. In order to achieve growth in non-interest income, management from time to time evaluates new products, new lines of business and the expansion of existing lines of business. Any new product introduction or new market entry could place additional demands on capital and managerial resources.

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Non-interest Expense
The components of non-interest expense were as follows (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Salaries and employee benefits
$
67,882

 
$
56,722

 
$
194,039

 
$
162,904

Net occupancy expense
6,436

 
5,634

 
19,062

 
17,284

Marketing
7,242

 
4,292

 
18,349

 
12,686

Legal and professional
6,395

 
5,333

 
20,975

 
16,883

Communications and technology
6,002

 
6,620

 
24,414

 
19,228

FDIC insurance assessment
6,203

 
6,355

 
16,800

 
17,867

Servicing related expenses
3,897

 
620

 
8,329

 
1,305

Other(1)
10,773

 
9,223

 
30,770

 
27,717

Total non-interest expense
$
114,830

 
$
94,799

 
$
332,738

 
$
275,874

 
(1)
Other expense includes such items as courier expenses, regulatory assessments other than FDIC insurance, due from bank charges and other general operating expenses, none of which account for 1% or more of total interest income and non-interest income.
Non-interest expense for the third quarter of 2017 increased $20.0 million, or 21%, to $114.8 million from $94.8 million in the third quarter of 2016. The increase is primarily due to increases of $11.2 million in salaries and employee benefits expense, $3.0 million in marketing expense and $1.1 million in legal and professional expense, all of which were due to general business growth and continued build-out. Also contributing to the year-over-year increase in non-interest expense was a $3.3 million increase in servicing related expenses resulting from an increase in MSRs, which are being amortized.
Non-interest expense for the nine months ended September 30, 2017 increased $56.9 million, or 21%, to $332.7 million from $275.9 million for the nine months ended September 30, 2016. The increase is primarily attributable to increases of $31.1 million in salaries and employee benefits expense, $5.7 million in marketing expense, $4.1 million in legal and professional expense, and $1.8 million in net occupancy expense, all of which were due to general business growth and continued build-out. The $5.2 million increase in communications and technology expense primarily relates to the $5.3 million technology write-off taken in the second quarter of 2017, as well as general business growth and continued build-out. The $7.0 million increase in servicing related expenses resulting from an increase in MSRs, which are being amortized.
Analysis of Financial Condition
Loans Held for Investment
Loans were as follows as of the dates indicated (in thousands):
 
September 30,
2017
 
December 31,
2016
Commercial
$
8,810,825

 
$
7,291,545

Mortgage finance
5,642,285

 
4,497,338

Construction
2,099,355

 
2,098,706

Real estate
3,683,564

 
3,462,203

Consumer
70,436

 
34,587

Leases
259,720

 
185,529

Gross loans held for investment
20,566,185

 
17,569,908

Deferred income (net of direct origination costs)
(95,494
)
 
(71,559
)
Allowance for loan losses
(182,929
)
 
(168,126
)
Total loans held for investment, net
$
20,287,762

 
$
17,330,223

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

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Table of Contents

operations in which we invest in mortgage loan ownership interests that are typically sold within 10 to 20 days. Volumes fluctuate based on the level of market demand for the product and the number of days between purchase and sale of the loans, as well as overall market interest rates and tend to peak at the end of each month.
We originate a substantial majority of all loans held for investment (excluding mortgage finance loans). We also participate in syndicated loan relationships, both as a participant and as an agent. As of September 30, 2017, we had $2.6 billion in syndicated loans, $797.4 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, 2017, $23.6 million of our syndicated loans were on non-accrual.
Portfolio Geographic Concentration
When considering our mortgage finance loans and other national lines of business, more than 50% of our loan exposure is outside of Texas and more than 50% of our deposits are sourced outside of Texas. However, as of September 30, 2017, a majority of our loans held for investment, excluding our mortgage finance loans and other national lines of business, were to businesses with headquarters and operations in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. We also make loans to these customers that are secured by assets located outside of Texas. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for loan losses.
Summary of Loan Loss Experience
The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the allowance for loan losses at a level consistent with management’s assessment of the collectability of the loan portfolio in light of current economic conditions and market trends. We recorded a provision for credit losses of $20.0 million during the third quarter of 2017 compared to $22.0 million in the third quarter of 2016 and $13.0 million in the second quarter of 2017. The decrease in provision recorded during the third quarter of 2017 compared to the same period in 2016 was primarily related to improvements in the composition of our pass-rated and classified loan portfolios, including energy loans, offset by a $4.5 million provision related to the potential impact to our loan portfolio from Hurricanes Harvey and Irma and increased provision for loan growth.
The allowance for credit losses, which includes a liability for losses on unfunded commitments, totaled $192.7 million at September 30, 2017, $179.5 million at December 31, 2016 and $191.3 million at September 30, 2016. The combined allowance as a percentage of loans held for investment excluding mortgage finance loans decreased to 1.30% at September 30, 2017 from 1.38% and1.51% at December 31, 2016 and September 30, 2016, respectively, as a result of strong loan growth.
The allowance for credit losses results from consistent application of our loan loss reserve methodology. At September 30, 2017, we believe the allowance is sufficient to cover all inherent losses in the portfolio and has been derived from consistent application of our methodology. Should any of the factors considered by management in evaluating the appropriateness of the allowance for loan losses change, our estimate of inherent losses in the portfolio could also change, which would affect the level of future provisions for loan losses.

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Activity in the allowance for loan losses is presented in the following table (in thousands, except percentage and multiple data):
 
Nine months ended 
 September 30, 2017
 
Year ended
December 31,
2016
 
Nine months ended 
 September 30, 2016
Allowance for loan losses:
 
 
 
 
 
Beginning balance
$
168,126

 
$
141,111

 
$
141,111

Loans charged-off:
 
 
 
 
 
Commercial
32,146

 
56,558

 
34,232

Construction
59

 

 

Real estate
290

 
528

 
528

Consumer
180

 
47

 
40

Leases

 

 

Total charge-offs
32,675

 
57,133

 
34,800

Recoveries:
 
 
 
 
 
Commercial
3,574

 
9,364

 
7,829

Construction
104

 
34

 
34

Real estate
74

 
63

 
36

Consumer
56

 
21

 
16

Leases
9

 
77

 
71

Total recoveries
3,817

 
9,559

 
7,986

Net charge-offs
28,858

 
47,574

 
26,814

Provision for loan losses
43,661

 
74,589

 
66,139

Ending balance
$
182,929

 
$
168,126

 
$
180,436

Allowance for off-balance sheet credit losses:
 
 
 
 
 
Beginning balance
$
11,422

 
$
9,011

 
$
9,011

Provision for off-balance sheet credit losses
(1,661
)
 
2,411

 
1,861

Ending balance
$
9,761

 
$
11,422

 
$
10,872

Total allowance for credit losses
$
192,690

 
$
179,548

 
$
191,308

Total provision for credit losses
$
42,000

 
$
77,000

 
$
68,000

Allowance for loan losses to LHI
0.89
%
 
0.96
%
 
1.02
%
Allowance for loan losses to LHI excluding mortgage finance loans
1.23
%
 
1.29
%
 
1.42
%
Net charge-offs to average LHI(1)
0.22
%
 
0.29
%
 
0.22
%
Net charge-offs to average LHI excluding mortgage finance loans(1)
0.28
%
 
0.38
%
 
0.29
%
Total provision for credit losses to average LHI(1)
0.32
%
 
0.46
%
 
0.55
%
Total provision for credit losses to average LHI excluding mortgage finance loans(1)
0.41
%
 
0.62
%
 
0.74
%
Recoveries to total charge-offs
11.68
%
 
16.73
%
 
22.95
%
Allowance for off-balance sheet credit losses to off-balance sheet credit commitments
0.14
%
 
0.19
%
 
0.19
%
Combined allowance for credit losses to LHI
0.94
%
 
1.03
%
 
1.09
%
Combined allowance for credit losses to LHI excluding mortgage finance loans
1.30
%
 
1.38
%
 
1.51
%
Non-performing assets:
 
 
 
 
 
Non-accrual loans(2)
$
118,205

 
$
167,791

 
$
169,113

OREO(3)
18,131

 
18,961

 
19,009

Total
$
136,336

 
$
186,752

 
$
188,122

Loans past due 90 days and still accruing(4)
8,892

 
10,729

 
9,706

Allowance for loan losses to non-accrual loans
1.5x

 
1.0x

 
1.1x

 
(1)
Interim period ratios are annualized.
(2)
As of September 30, 2017December 31, 2016 and September 30, 2016, non-accrual loans included $12.0 million, $18.1 million and $19.7 million, respectively, in loans that met the criteria for restructured.

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(3)
We recorded a $101,000 valuation allowance against the OREO balance at September 30, 2017, compared to none at December 31, 2016 and September 30, 2016.
(4)
At September 30, 2017December 31, 2016 and September 30, 2016, loans past due 90 days and still accruing include premium finance loans of $8.4 million, $6.8 million and $7.7 million, respectively.
Non-performing Assets
Non-performing assets include non-accrual loans and leases and repossessed assets. The table below summarizes our non-accrual loans by type and by type of property securing the credit and OREO (in thousands): 
 
September 30,
2017
 
December 31,
2016
 
September 30,
2016
 
 
 
 
 
 
Non-accrual loans:(1)
 
 
 
 
 
Commercial
 
 
 
 
 
     Oil and gas properties
$
80,142

 
$
115,599

 
$
143,372

     Assets of the borrowers
9,841

 
18,592

 
17,335

     Inventory
23,121

 
27,630

 
2,020

    Other
3,283

 
3,119

 
3,606

Total commercial
116,387

 
164,940

 
166,333

Construction
 
 
 
 
 
     Commercial buildings

 

 

     Unimproved land

 

 

     Other

 
159

 
159

Total construction

 
159

 
159

Real estate
 
 
 
 
 
     Commercial property
1,123

 
2,083

 
2,087

     Unimproved land and/or developed residential lots

 

 

     Single family residences

 

 

     Farm land

 
326

 

     Other
695

 

 
334

Total real estate
1,818

 
2,409

 
2,421

Consumer

 
200

 
200

Leases

 
83

 

Total non-accrual loans
118,205

 
167,791

 
169,113

Repossessed assets:
 
 
 
 
 
OREO(2)
18,131

 
18,961

 
19,009

Other repossessed assets

 

 

Total non-performing assets
$
136,336

 
$
186,752

 
$
188,122


(1)
As of September 30, 2017December 31, 2016 and September 30, 2016, non-accrual loans included $12.0 million, $18.1 million and $19.7 million, respectively, in loans that met the criteria for restructured.
(2)
We recorded a $101,000 valuation allowance against the OREO balance at September 30, 2017, compared to none at December 31, 2016 and September 30, 2016.
Total non-performing assets at September 30, 2017 decreased $51.8 million from September 30, 2016 and $50.4 million from December 31, 2016. We experienced a significant decrease in levels of non-performing assets during the nine months ended September 30, 2017 compared to the same period in 2016, primarily related to improvements in our energy portfolio. Energy non-performing assets totaled $81.6 million at September 30, 2017 compared to $121.5 million at December 31, 2016 and $129.3 million at September 30, 2016. Our provision for credit losses decreased as a result of these improvements, as well as improvements in the composition of our pass-rated and classified loan portfolios. This resulted in a decrease in the reserve for loan losses as a percent of loans excluding mortgage finance loans for September 30, 2017 compared to December 31, 2016 and September 30, 2016.

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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, 2017, we had $34.6 million in loans of this type, compared to $19.3 million at December 31, 2016, which were not included in either non-accrual or 90 days past due categories.
Loans Held for Sale
We launched our MCA business in the third quarter of 2015. In that business, we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to Ginnie Mae and GSEs such as Fannie Mae and Freddie Mac. For additional information on our loans held for sale portfolio, see Note 6 - Certain Transfers of Financial Assets in the accompanying notes to the consolidated financial statements included elsewhere in this report.


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Liquidity and Capital Resources
In general terms, liquidity is a measurement of our ability to meet our cash needs. Our objective in managing our liquidity is to maintain our ability to meet loan commitments, purchase securities or repay deposits and other liabilities in accordance with their terms, without an adverse impact on our current or future earnings. Our liquidity strategy is guided by policies, formulated and monitored by our senior management and our Balance Sheet Management Committee (“BSMC”), which take into account the demonstrated marketability of assets, the sources and stability of our funding and the level of unfunded commitments. We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost effectiveness. For the year ended December 31, 2016 and for the nine months ended September 30, 2017 our principal source of funding has been our customer deposits, supplemented by our short-term and long-term borrowings, primarily from Federal funds purchased and Federal Home Loan Bank ("FHLB") borrowings, which are generally used to fund mortgage finance assets.
Liquidity assets were $2.4 billion at September 30, 2017, and continue to be significant as a result of deposit growth and increases in borrowing capacity related to our mortgage finance loans. The following table summarizes the composition of liquidity assets (in thousands):
 
September 30,
2017
 
December 31,
2016
 
September 30,
2016
Federal funds sold and securities purchased under resale agreements
$
25,000

 
$
25,000

 
$
30,000

Interest-bearing deposits
2,332,537

 
2,700,645

 
3,441,074

Total liquidity assets
$
2,357,537

 
$
2,725,645

 
$
3,471,074

 
 
 
 
 
 
Total liquidity assets as a percent of:
 
 
 
 
 
Total loans held for investment, excluding mortgage finance loans
15.9
%
 
21.0
%
 
27.4
%
Total loans held for investment
11.5
%
 
15.6
%
 
19.7
%
Total earning assets
10.0
%
 
12.9
%
 
16.1
%
Total deposits
12.4
%
 
16.0
%
 
19.1
%
Our liquidity needs to support growth in loans held for investment have been fulfilled primarily through growth in our core customer deposits. Our goal is to obtain as much of our funding for loans held for investment and other earning assets as possible from deposits of these core customers. These deposits are generated principally through development of long-term relationships with customers, with a significant focus on treasury management products. In addition to deposits from our core customers, we also have access to deposits through brokered customer relationships. For regulatory purposes, these relationship brokered deposits are categorized as brokered deposits; however, since these deposits arise from a customer relationship, which involves extensive treasury services, we consider these deposits to be core deposits for our reporting purposes.

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We also have access to incremental deposits through brokered retail certificates of deposit, or CDs. These traditional brokered deposits are generally of short maturities, 30 to 90 days, and are used to fund temporary differences in the growth in loans balances, including growth in loans held for sale or other specific categories of loans as compared to customer deposits. The following table summarizes our period-end and average year-to-date core customer deposits, relationship brokered deposits and traditional brokered deposits (in millions):
 
September 30,
2017
 
December 31,
2016
 
September 30,
2016
Deposits from core customers
$
17,259.2

 
$
15,400.5

 
$
16,633.0

Deposits from core customers as a percent of total deposits
90.5
%
 
90.5
%
 
91.7
%
Relationship brokered deposits
$
1,822.1

 
$
1,616.3

 
$
1,512.2

Relationship brokered deposits as a percent of total deposits
9.5
%
 
9.5
%
 
8.3
%
Traditional brokered deposits
$

 
$

 
$

Traditional brokered deposits as a percent of total deposits
%
 
%
 
%
Average deposits from core customers(1)
$
16,239.7

 
$
15,723.8

 
$
15,277.0

Average deposits from core customers as a percent of total quarterly average deposits(1)
91.4
%
 
91.3
%
 
91.2
%
Average relationship brokered deposits(1)
$
1,527.1

 
$
1,496.1

 
$
1,480.6

Average relationship brokered deposits as a percent of total quarterly average deposits(1)
8.6
%
 
8.7
%
 
8.8
%
Average traditional brokered deposits(1)
$

 
$

 
$

Average traditional brokered deposits as a percent of total quarterly average deposits(1)
%
 
%
 
%
(1)
Annual averages presented for December 31, 2016.
We have access to sources of traditional brokered deposits that we estimate to be $3.5 billion. Based on our internal guidelines, we have chosen to limit our use of these sources to a lesser amount. Customer deposits (total deposits, including relationship brokered deposits, minus brokered CDs) at September 30, 2017 increased by $2.1 billion from December 31, 2016 and increased $936.1 million from September 30, 2016.
We have short-term borrowing sources available to supplement deposits and meet our funding needs. Such borrowings are generally used to fund our mortgage finance assets, due to their liquidity, short duration and interest spreads available. These borrowing sources include Federal funds purchased from our downstream correspondent bank relationships (which consist of banks that are smaller than our bank) and from our upstream correspondent bank relationships (which consist of banks that are larger than our bank), customer repurchase agreements, treasury, tax and loan notes and advances from the FHLB and the Federal Reserve. The following table summarizes our short-term borrowings as of September 30, 2017 (in thousands): 
 
 
Federal funds purchased
$
75,800

Repurchase agreements
7,696

FHLB borrowings
2,500,000

Line of credit

Total short-term borrowings
$
2,583,496

Maximum short-term borrowings outstanding at any month-end during 2017
$
3,162,224

The following table summarizes our other borrowing capacities in excess of balances outstanding at September 30, 2017 (in thousands): 
 
 
FHLB borrowing capacity relating to loans
$
4,218,138

FHLB borrowing capacity relating to securities
1,424

Total FHLB borrowing capacity
$
4,219,562

Unused Federal funds lines available from commercial banks
$
1,164,000


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The following table summarizes our long-term borrowings as of September 30, 2017 (in thousands):
 
 
Subordinated notes
$
281,315

Trust preferred subordinated debentures
113,406

Total long-term borrowings
$
394,721

At September 30, 2017, we had a revolving, non-amortizing line of credit with a maximum availability of $130.0 million. This line of credit matures on December 19, 2017. The loan proceeds may be used for general corporate purposes including funding regulatory capital infusions into the Bank. The loan agreement contains customary financial covenants and restrictions. As of September 30, 2017 and December 31, 2016, there were no borrowings outstanding.
Our equity capital, including $150 million in preferred stock, averaged $2.1 billion for the nine months ended September 30, 2017, as compared to $1.7 billion for the same period in 2016. We have not paid any cash dividends on our common stock since we commenced operations and have no plans to do so in the foreseeable future.
As of September 30, 2017, our capital ratios were above the levels required to be well capitalized. We believe that our earnings, periodic capital raising transactions and the addition of loan and deposit relationships will allow us to continue to grow organically.

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Commitments and Contractual Obligations
The following table presents significant fixed and determinable contractual payment obligations to third parties by payment date. Payments for borrowings do not include interest. Payments related to leases are based on actual payments specified in the underlying contracts. As of September 30, 2017, our significant fixed and determinable contractual obligations to third parties, excluding interest, were as follows (in thousands):
 
 
Within One
Year
 
After One but
Within Three
Years
 
After Three but
Within Five
Years
 
After Five
Years
 
Total
Deposits without a stated maturity
$
18,548,721

 
$

 
$

 
$

 
$
18,548,721

Time deposits
491,917

 
40,075

 
544

 

 
532,536

Federal funds purchased and customer repurchase agreements
83,496

 

 

 

 
83,496

FHLB borrowings
2,500,000

 

 

 

 
2,500,000

Operating lease obligations(1)
16,355

 
31,809

 
25,832

 
20,429

 
94,425

Subordinated notes

 

 

 
281,315

 
281,315

Trust preferred subordinated debentures

 

 

 
113,406

 
113,406

Total contractual obligations
$
21,640,489

 
$
71,884

 
$
26,376

 
$
415,150

 
$
22,153,899

 
(1)
Non-balance sheet item.
Critical Accounting Policies
SEC guidance requires disclosure of “critical accounting policies.” The SEC defines “critical accounting policies” as those that are most important to the presentation of a company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States. The more significant of these policies are summarized in Note 1 - Operations and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in the 2016 Form 10-K. Not all significant accounting policies require management to make difficult, subjective or complex judgments. However, the policy noted below could be deemed to meet the SEC’s definition of a critical accounting policy.
Allowance for Loan Losses
Management considers the policies related to the allowance for loan losses as the most critical to the financial statement presentation. The total allowance for loan losses includes activity related to allowances calculated in accordance with Accounting Standards Codification (“ASC”) 310, Receivables, and ASC 450, Contingencies. The allowance for loan losses is established through a provision for credit losses charged to current earnings. The amount maintained in the allowance reflects management’s continuing evaluation of the loan losses inherent in the loan portfolio. The allowance for loan losses is comprised of specific reserves assigned to certain classified loans and general reserves. Factors contributing to the determination of specific reserves include the creditworthiness of the borrower, and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral-dependent loans. For purposes of determining the general allowance, the portfolio is segregated by product types in order to recognize differing risk profiles among categories, and then further segregated by credit grades. See “Summary of Loan Loss Experience” above and Note 4 – Loans Held for Investment and Allowance for Loan Losses in the accompanying notes to the consolidated financial statements included elsewhere in this report for further discussion of the risk factors considered by management in establishing the allowance for loan losses.

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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. These changes may be the result of various factors, including interest rates, foreign exchange rates, commodity prices, or equity prices. Additionally, the financial instruments subject to market risk can be classified either as held for trading purposes or held for other than trading.
We are subject to market risk primarily through the effect of changes in interest rates on our portfolio of assets held for purposes other than trading. Additionally, we have some market risk relative to commodity prices through our energy lending activities. Petroleum and natural gas commodity prices declined substantially beginning in 2014, and prices have continued to be suppressed through 2017. Such declines in commodity prices have and, if continued, could negatively impact our energy clients' ability to perform on their loan obligations. Management does not currently expect the current decline in commodity prices to have a material adverse effect on our financial position. Foreign exchange rates, commodity prices and/or equity prices do not pose significant market risk to us.
The responsibility for managing market risk rests with the BSMC, which operates under policy guidelines established by our board of directors. The negative acceptable variation in net interest revenue due to a 200 basis point increase or decrease in interest rates is generally limited by these guidelines to plus or minus 5%. These guidelines also establish maximum levels for short-term borrowings, short-term assets and public and brokered deposits. They also establish minimum levels for unpledged assets, 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, 2017, and is not necessarily indicative of positions on other dates. The balances of interest rate sensitive assets and liabilities are presented in the periods in which they next reprice to market rates or mature and are aggregated to show the interest rate sensitivity gap. The mismatch between repricings or maturities within a time period is commonly referred to as the “gap” for that period. A positive gap (asset sensitive), where interest-rate sensitive assets exceed interest rate sensitive liabilities, generally will result in the net interest margin increasing in a rising rate environment and decreasing in a falling rate environment. A negative gap (liability sensitive) will generally have the opposite results on the net interest margin. To reflect anticipated prepayments, certain asset and liability categories are shown in the table using estimated cash flows rather than contractual cash flows. The Company employs interest rate floors in certain variable rate loans to enhance the yield on those loans at times when market interest rates are extraordinarily low. The degree of asset sensitivity, spreads on loans and net interest margin may be reduced until rates increase by an amount sufficient to eliminate the effects of floors. The adverse effect of floors as market rates increase may also be offset by the positive gap, the extent to which rates on deposits and other funding sources lag increasing market rates and changes in composition of funding.

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Table of Contents

Interest Rate Sensitivity Gap Analysis
September 30, 2017
(In thousands)
 
 
0-3 mo
Balance
 
4-12 mo
Balance
 
1-3 yr
Balance
 
3+ yr
Balance
 
Total
Balance
Assets:
 
 
 
 
 
 
 
 
 
Interest-bearing deposits, federal funds sold and securities purchased under resale agreements
$
2,357,537

 
$

 

 
$

 
$
2,357,537

Securities(1)
7,397

 
2,725

 
1,158

 
12,944

 
24,224

Total variable loans
18,252,896

 
80,080

 
13,745

 

 
18,346,721

Total fixed loans
496,354

 
1,439,840

 
704,826

 
534,427

 
3,175,447

Total loans(2)
18,749,250

 
1,519,920

 
718,571

 
534,427

 
21,522,168

Total interest sensitive assets
$
21,114,184

 
$
1,522,645

 
$
719,729

 
$
547,371

 
$
23,903,929

Liabilities:
 
 
 
 
 
 
 
 
 
Interest-bearing customer deposits
$
10,285,519

 
$

 
$

 
$

 
$
10,285,519

CDs & IRAs
178,361

 
313,556

 
40,075

 
544

 
532,536

Traditional brokered deposits

 

 

 

 

Total interest-bearing deposits
10,463,880

 
313,556

 
40,075

 
544

 
10,818,055

Repurchase agreements, Federal funds
     purchased, FHLB borrowings, line
     of credit
2,583,496

 

 

 

 
2,583,496

Subordinated notes

 

 

 
281,315

 
281,315

Trust preferred subordinated debentures

 

 

 
113,406

 
113,406

Total borrowings
2,583,496

 

 

 
394,721

 
2,978,217

Total interest sensitive liabilities
$
13,047,376

 
$
313,556

 
$
40,075

 
$
395,265

 
$
13,796,272

Gap
$
8,066,808

 
$
1,209,089

 
$
679,654

 
$
152,106

 
$

Cumulative Gap
8,066,808

 
9,275,897

 
9,955,551

 
10,107,657

 
10,107,657

 
 
 
 
 
 
 
 
 
 
Demand deposits
 
 
 
 
 
 
 
 
$
8,263,202

Stockholders’ equity
 
 
 
 
 
 
 
 
2,158,363

Total
 
 
 
 
 
 
 
 
$
10,421,565

 
(1)
Securities based on fair market value.
(2)
Loans are stated at gross.
The table above sets forth the balances as of September 30, 2017 for interest-bearing assets, interest-bearing liabilities and the total of non-interest-bearing deposits and stockholders’ equity. While a gap interest table is useful in analyzing interest rate sensitivity, an interest rate sensitivity simulation provides a better illustration of the sensitivity of earnings to changes in interest rates. Earnings are also affected by changing interest rates on the value of funding derived from demand deposits and stockholders’ equity. We perform a sensitivity analysis to identify interest rate risk exposure on net interest income. We quantify and measure interest rate risk exposure using a model to dynamically simulate the effect of changes in net interest income relative to changes in interest rates and loan and deposit account balances over the next twelve months based on three interest rate scenarios. These are a “most likely” rate scenario and two “shock test” scenarios.
The “most likely” rate scenario is based on the consensus forecast of future interest rates published by independent sources. These forecasts incorporate future spot rates and relevant spreads of instruments that are actively traded in the open market. The Federal Reserve’s Federal funds target affects short-term borrowing rates; the prime lending rate and LIBOR are the basis for most of our variable-rate loan pricing. The 10-year mortgage rate is also monitored because of its effect on prepayment speeds for mortgage-backed securities. We believe these are our primary interest rate exposures. We are not currently using derivatives to manage our interest rate exposure.

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The two “shock test” scenarios assume a sustained parallel 100 and 200 basis point increase in interest rates. As short-term rates have remained low through 2016 and the first nine months of 2017, we do not believe that analysis of an assumed decrease in interest rates would provide meaningful results. We will continue to evaluate these scenarios as interest rates change, until short-term rates rise above 3.0%, at which point we will resume evaluations of shock scenarios in which interest rates decrease.

Our interest rate risk exposure model incorporates assumptions regarding the level of interest rate or balance changes on indeterminable maturity deposits (demand deposits, interest-bearing transaction accounts and savings accounts) for a given level of market rate changes. These assumptions have been developed through a combination of historical analysis and future expected pricing behavior. Changes in prepayment behavior of mortgage-backed securities and residential and commercial mortgage loans in each rate environment are captured using industry estimates of prepayment speeds for various coupon segments of the portfolio. The impact of planned growth and new business activities is factored into the simulation model. This modeling indicated interest rate sensitivity as follows (in thousands):
 
 
Anticipated Impact Over the Next Twelve Months as Compared to Most Likely Scenario
 
Anticipated Impact Over the Next Twelve Months as Compared to Most Likely Scenario
 
100 bp Increase
 
200 bp Increase
 
100 bp Increase
 
200 bp Increase
 
September 30, 2017
 
September 30, 2016
Change in net interest income
$
114,593

 
$
231,113

 
$
117,094

 
$
241,366

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

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Table of Contents

ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the supervision and participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based upon that evaluation, we have concluded that, as of the end of such period, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS
We are subject to various claims and legal actions related to operating activities that arise in the ordinary course of business. Management does not currently expect the ultimate disposition of these matters to have a material adverse impact on our financial statements.
 
ITEM 1A.
RISK FACTORS
There have been no material changes in the risk factors previously disclosed in the 2016 Form 10-K.



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Table of Contents

ITEM 6.
EXHIBITS
 
(a)
Exhibits
 
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
32.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith.
 
32.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith.
 
101
The following materials from Texas Capital Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Statements of Income, (ii) Consolidated Balance Sheets, (iii) Consolidated Statements of Cash Flows, and (iv) Notes to Consolidated Financial Statements


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Table of Contents

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 19, 2017
/s/ Julie Anderson
Julie Anderson
Chief Financial Officer
(Duly authorized officer and principal financial officer)



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EXHIBIT INDEX
 
 
 
Exhibit Number
 
31.1
31.2
32.1
32.2
101
The following materials from Texas Capital Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Statements of Income, (ii) Consolidated Balance Sheets, (iii) Consolidated Statements of Cash Flows, and (iv) Notes to Consolidated Financial Statements




51