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, 2016

¨
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 or a non-accelerated filer. See definition of “large accelerated filer” and “accelerated filer” Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
 
ý
  
Accelerated Filer
 
¨
 
 
 
 
Non-Accelerated Filer
 
¨
  
Smaller Reporting Company
 
¨

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 20, 2016, 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 46,013,269
 


Table of Contents

Texas Capital Bancshares, Inc.
Form 10-Q
Quarter Ended September 30, 2016
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,
2016
 
December 31,
2015
 
(Unaudited)
 
 
Assets
 
 
 
Cash and due from banks
$
117,345

 
$
109,496

Interest-bearing deposits
3,441,074

 
1,626,374

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

 
55,000

Securities, available-for-sale
26,356

 
29,992

Loans held for sale, at fair value
648,684

 
86,075

Loans held for investment, mortgage finance
4,961,159

 
4,966,276

Loans held for investment (net of unearned income)
12,662,394

 
11,745,674

Less: Allowance for loan losses
180,436

 
141,111

Loans held for investment, net
17,443,117

 
16,570,839

Mortgage servicing rights, net
15,462

 
423

Premises and equipment, net
20,604

 
23,561

Accrued interest receivable and other assets
454,116

 
382,101

Goodwill and intangible assets, net
19,630

 
19,960

Total assets
$
22,216,388

 
$
18,903,821

Liabilities and Stockholders’ Equity
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
8,789,740

 
$
6,386,911

Interest-bearing
9,355,383

 
8,697,708

Total deposits
18,145,123

 
15,084,619

Accrued interest payable
3,124

 
5,097

Other liabilities
196,579

 
153,433

Federal funds purchased and repurchase agreements
81,420

 
143,051

Other borrowings
1,670,000

 
1,500,000

Subordinated notes, net
280,954

 
280,682

Trust preferred subordinated debentures
113,406

 
113,406

Total liabilities
20,490,606

 
17,280,288

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, 2016 and December 31, 2015
150,000

 
150,000

Common stock, $.01 par value:
 
 
 
Authorized shares – 100,000,000
 
 
 
Issued shares – 46,009,912 and 45,874,224 at September 30, 2016 and December 31, 2015, respectively
460

 
459

Additional paid-in capital
717,452

 
714,546

Retained earnings
857,238

 
757,818

Treasury stock (shares at cost: 417 at September 30, 2016 and December 31, 2015)
(8
)
 
(8
)
Accumulated other comprehensive income, net of taxes
640

 
718

Total stockholders’ equity
1,725,782

 
1,623,533

Total liabilities and stockholders’ equity
$
22,216,388

 
$
18,903,821

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,
 
2016
 
2015
 
2016
 
2015
Interest income
 
 
 
 
 
 
 
Interest and fees on loans
$
177,724

 
$
151,749

 
$
501,673

 
$
442,529

Securities
232

 
298

 
739

 
979

Federal funds sold and securities purchased under resale agreements
455

 
193

 
1,209

 
427

Deposits in other banks
4,081

 
1,616

 
11,116

 
4,203

Total interest income
182,492

 
153,856

 
514,737

 
448,138

Interest expense
 
 
 
 
 
 
 
Deposits
8,950

 
6,240

 
26,743

 
17,510

Federal funds purchased
126

 
56

 
362

 
217

Repurchase agreements
3

 
6

 
8

 
14

Other borrowings
1,730

 
672

 
4,257

 
1,590

Subordinated notes
4,191

 
4,191

 
12,573

 
12,573

Trust preferred subordinated debentures
753

 
643

 
2,203

 
1,892

Total interest expense
15,753

 
11,808

 
46,146

 
33,796

Net interest income
166,739

 
142,048

 
468,591

 
414,342

Provision for credit losses
22,000

 
13,750

 
68,000

 
39,250

Net interest income after provision for credit losses
144,739

 
128,298

 
400,591

 
375,092

Non-interest income
 
 
 
 
 
 
 
Service charges on deposit accounts
2,880

 
2,096

 
7,401

 
6,339

Trust fee income
1,113

 
1,222

 
3,024

 
3,709

Bank owned life insurance (BOLI) income
520

 
484

 
1,592

 
1,444

Brokered loan fees
7,581

 
4,885

 
18,090

 
14,394

Swap fees
918

 
254

 
2,330

 
3,275

Other
3,704

 
2,439

 
9,508

 
7,257

Total non-interest income
16,716

 
11,380

 
41,945

 
36,418

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
56,722

 
48,583

 
162,904

 
142,611

Net occupancy expense
5,634

 
5,874

 
17,284

 
17,373

Marketing
4,292

 
3,999

 
12,686

 
12,142

Legal and professional
5,333

 
5,510

 
16,883

 
15,176

Communications and technology
6,620

 
5,180

 
19,228

 
15,905

FDIC insurance assessment
6,355

 
4,489

 
17,867

 
12,490

Allowance and other carrying costs for OREO
269

 
1

 
765

 
16

Other
9,574

 
8,052

 
28,257

 
23,768

Total non-interest expense
94,799

 
81,688

 
275,874

 
239,481

Income before income taxes
66,656

 
57,990

 
166,662

 
172,029

Income tax expense
23,931

 
20,876

 
59,929

 
61,928

Net income
42,725

 
37,114

 
106,733

 
110,101

Preferred stock dividends
2,438

 
2,438

 
7,313

 
7,313

Net income available to common stockholders
$
40,287

 
$
34,676

 
$
99,420

 
$
102,788

Other comprehensive income (loss)
 
 
 
 
 
 
 
Change in net unrealized gain on available-for-sale securities arising during period, before-tax
$
(63
)
 
$
(216
)
 
$
(121
)
 
$
(613
)
Income tax benefit related to net unrealized gain on available-for-sale securities
(23
)
 
(75
)
 
(43
)
 
(214
)
Other comprehensive loss, net of tax
(40
)
 
(141
)
 
(78
)
 
(399
)
Comprehensive income
$
42,685

 
$
36,973

 
$
106,655

 
$
109,702

 
 
 
 
 
 
 
 
Basic earnings per common share
$
0.88

 
$
0.76

 
$
2.16

 
$
2.24

Diluted earnings per common share
$
0.87

 
$
0.75

 
$
2.14

 
$
2.21

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, 2014 (audited)
6,000,000

 
$
150,000

 
45,735,424

 
$
457

 
$
709,738

 
$
622,714

 
(417
)
 
$
(8
)
 
$
1,289

 
$
1,484,190

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 
110,101

 

 

 

 
110,101

Change in unrealized gain on available-for-sale securities, net of taxes of $214

 

 

 

 

 

 

 

 
(399
)
 
(399
)
Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
109,702

Tax benefit related to exercise of stock-based awards

 

 

 

 
1,092

 

 

 

 

 
1,092

Stock-based compensation expense recognized in earnings

 

 

 

 
3,328

 

 

 

 

 
3,328

Issuance of preferred stock

 

 

 

 

 

 

 

 

 

Preferred stock dividend

 

 

 

 

 
(7,313
)
 

 

 

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

 

 
135,688

 
1

 
(949
)
 

 

 

 

 
(948
)
Balance at September 30, 2015
6,000,000

 
$
150,000

 
45,871,112

 
$
458

 
$
713,209

 
$
725,502

 
(417
)
 
$
(8
)
 
$
890

 
$
1,590,051

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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

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,
 
2016
 
2015
Operating activities
 
 
 
Net income
$
106,733

 
$
110,101

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
68,000

 
39,250

Depreciation and amortization
16,179

 
12,230

Increase in valuation allowance on mortgage servicing rights
414

 

Bank owned life insurance (BOLI) income
(1,592
)
 
(1,444
)
Stock-based compensation expense
6,175

 
9,286

Excess tax benefits from stock-based compensation arrangements
(1,328
)
 
(1,134
)
Purchases of loans held for sale
(1,927,702
)
 
(4,440
)
Proceeds from sales and repayments of loans held for sale
1,368,666

 
3,378

Capitalization of mortgage servicing rights
(16,344
)
 

(Gain) loss on sale of loans held for sale and other assets
(1,307
)
 
134

Changes in operating assets and liabilities:
 
 
 
Accrued interest receivable and other assets
(79,267
)
 
(77,873
)
Accrued interest payable and other liabilities
34,172

 
2,339

Net cash provided by (used in) operating activities
(427,201
)
 
91,827

Investing activities
 
 
 
Purchases of available-for-sale securities
(1,278
)
 

Maturities and calls of available-for-sale securities
265

 
2,430

Principal payments received on available-for-sale securities
4,528

 
6,677

Originations of mortgage finance loans
(74,594,117
)
 
(66,786,322
)
Proceeds from pay-offs of mortgage finance loans
74,599,234

 
66,575,657

Net increase in loans held for investment, excluding mortgage finance loans
(943,534
)
 
(1,417,605
)
Purchase of premises and equipment, net
(1,526
)
 
(3,729
)
Proceeds from sale of foreclosed assets
62

 
1,430

Net cash used in investing activities
(936,366
)
 
(1,621,462
)
Financing activities
 
 
 
Net increase in deposits
3,060,504

 
2,492,045

Costs from issuance of stock related to stock-based awards and warrants
(1,772
)
 
(948
)
Preferred dividends paid
(7,313
)
 
(7,313
)
Net increase in other borrowings
170,000

 
149,995

Excess tax benefits from stock-based compensation arrangements
1,328

 
1,134

Net increase (decrease) in Federal funds purchased and repurchase agreements
(61,631
)
 
11,158

Net cash provided by financing activities
3,161,116

 
2,646,071

Net increase in cash and cash equivalents
1,797,549

 
1,116,436

Cash and cash equivalents at beginning of period
1,790,870

 
1,330,514

Cash and cash equivalents at end of period
$
3,588,419

 
$
2,446,950

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for interest
$
48,119

 
$
35,849

Cash paid during the period for income taxes
68,716

 
70,208

Transfers from loans/leases to OREO and other repossessed assets
18,822

 
1,177

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.
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, 2015, included in our Annual Report on Form 10-K filed with the SEC on February 18, 2016 (the “2015 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 values of certain assets and liabilities and the status of contingencies are particularly susceptible to significant change in the near term.

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,
 
2016
 
2015
 
2016
 
2015
Numerator:
 
 
 
 
 
 
 
Net income
$
42,725

 
$
37,114

 
$
106,733

 
$
110,101

Preferred stock dividends
2,438

 
2,438

 
7,313

 
7,313

Net income available to common stockholders
40,287

 
34,676

 
$
99,420

 
102,788

Denominator:
 
 
 
 
 
 
 
Denominator for basic earnings per share— weighted average shares
45,980,517

 
45,827,902

 
45,931,357

 
45,792,470

Effect of employee stock-based awards(1)
118,885

 
216,499

 
119,021

 
216,448

Effect of warrants to purchase common stock
410,281

 
426,989

 
382,578

 
416,574

Denominator for dilutive earnings per share—adjusted weighted average shares and assumed conversions
46,509,683

 
46,471,390

 
46,432,956

 
46,425,492

Basic earnings per common share
$
0.88

 
$
0.76

 
$
2.16

 
$
2.24

Diluted earnings per common share
$
0.87

 
$
0.75

 
$
2.14

 
$
2.21

 
(1)
Stock options, SARs and RSUs outstanding of 319,476 at September 30, 2016 and 101,100 at September 30, 2015 have not been included in diluted earnings per share because to do so would have been anti-dilutive for the periods presented.
(3) SECURITIES
At September 30, 2016, our net unrealized gain on the available-for-sale securities portfolio was $985,000 compared to $1.1 million at December 31, 2015. As a percent of outstanding balances, the unrealized gain was 3.88% and 3.83% at September 30, 2016, and December 31, 2015, respectively. The increase in the unrealized gain percentage at September 30, 2016 results from the reduction in the portfolio balance due to paydowns and maturities.

8

Table of Contents

The following is a summary of available-for-sale securities (in thousands):
 
September 30, 2016

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair
Value
Available-for-sale securities:







Residential mortgage-backed securities
$
16,007


$
1,139

 
$

 
$
17,146

Municipals
564


2

 

 
566

Equity securities(1)
8,800


49

 
(205
)
 
8,644


$
25,371


$
1,190

 
$
(205
)
 
$
26,356

 
 
 
 
 
 
 
 
 
December 31, 2015
 
Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Estimated
Fair
Value
Available-for-sale securities:







Residential mortgage-backed securities
$
20,536

 
$
1,365

 
$

 
$
21,901

Municipals
828

 
3

 

 
831

Equity securities(1)
7,522

 
11

 
(273
)
 
7,260


$
28,886

 
$
1,379

 
$
(273
)
 
$
29,992

(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, 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
$
50

 
$
2,565

 
$
3,418

 
$
9,974

 
$
16,007

Estimated fair value
50

 
2,649

 
3,856

 
10,591

 
17,146

Weighted average yield(3)
5.50
%
 
4.70
%
 
5.54
%
 
2.69
%
 
3.63
%
Municipals:(2)
 
 
 
 
 
 
 
 
 
Amortized cost
275

 
289

 

 

 
564

Estimated fair value
275

 
291

 

 

 
566

Weighted average yield(3)
5.61
%
 
5.76
%
 

 

 
5.69
%
Equity securities:(4)
 
 
 
 
 
 
 
 
 
Amortized cost
8,800

 

 

 

 
8,800

Estimated fair value
8,644

 

 

 

 
8,644

Total available-for-sale securities:
 
 
 
 
 
 
 
 
 
Amortized cost
 
 
 
 
 
 
 
 
$
25,371

Estimated fair value
 
 
 
 
 
 
 
 
$
26,356


9

Table of Contents

 
December 31, 2015

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
$
214

 
$
4,655

 
$
4,265

 
$
11,402

 
$
20,536

Estimated fair value
217

 
4,837

 
4,747

 
12,100

 
21,901

Weighted average yield(3)
5.62
%
 
4.71
%
 
5.54
%
 
2.53
%
 
3.68
%
Municipals:(2)
 
 
 
 
 
 
 
 
 
Amortized cost
265

 
563

 

 

 
828

Estimated fair value
265

 
566

 

 

 
831

Weighted average yield(3)
5.46
%
 
5.69
%
 
%
 
%
 
5.62
%
Equity securities:(4)
 
 
 
 
 
 
 
 
 
Amortized cost
7,522

 

 

 

 
7,522

Estimated fair value
7,260

 

 

 

 
7,260

Total available-for-sale securities:
 
 
 
 
 
 
 
 
 
Amortized cost
 
 
 
 
 
 
 
 
$
28,886

Estimated fair value
 
 
 
 
 
 
 
 
$
29,992

(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.
Securities with carrying values of approximately $15.2 million were pledged to secure certain borrowings and deposits at September 30, 2016. Of the pledged securities at September 30, 2016, approximately $4.0 million were pledged for certain deposits, and approximately $11.2 million were pledged for repurchase agreements.
The following table discloses, as of September 30, 2016 and December 31, 2015, 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, 2016
Less Than 12 Months

12 Months or Longer

Total
 
Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss
Equity securities
$

 
$

 
$
6,295

 
$
(205
)
 
$
6,295

 
$
(205
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
Less Than 12 Months

12 Months or Longer

Total
 
Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss
Equity securities
$

 
$

 
$
6,227

 
$
(273
)
 
$
6,227

 
$
(273
)
At September 30, 2016, we owned one security with an unrealized loss position. This 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”. 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 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, 2016 and December 31, 2015, loans held for investment were as follows (in thousands):
 
 
September 30,
2016
 
December 31,
2015
Commercial
$
7,053,979

 
$
6,672,631

Mortgage finance
4,961,159

 
4,966,276

Construction
2,150,453

 
1,851,717

Real estate
3,391,831

 
3,139,197

Consumer
27,554

 
25,323

Leases
96,878

 
113,996

Gross loans held for investment
17,681,854

 
16,769,140

Deferred income (net of direct origination costs)
(58,301
)
 
(57,190
)
Allowance for loan losses
(180,436
)
 
(141,111
)
Total loans held for investment
$
17,443,117

 
$
16,570,839

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. September 30, 2016 and December 31, 2015 balances are stated net of $1.0 billion and $454.8 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.

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Table of Contents

At September 30, 2016 and December 31, 2015, 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 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, 2016 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, 2016 and December 31, 2015 (in thousands):

September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
6,605,475

 
$
4,961,159

 
$
2,130,826

 
$
3,348,510

 
$
27,210

 
$
92,875

 
$
17,166,055

Special mention
128,785

 

 
7,361

 
34,581

 

 
37

 
170,764

Substandard-accruing
153,386

 

 
12,107

 
6,319

 
144

 
3,966

 
175,922

Non-accrual
166,333

 

 
159

 
2,421

 
200

 

 
169,113

Total loans held for investment
$
7,053,979

 
$
4,961,159

 
$
2,150,453

 
$
3,391,831

 
$
27,554

 
$
96,878

 
$
17,681,854

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
6,375,332

 
$
4,966,276

 
$
1,821,678

 
$
3,085,463

 
$
25,093

 
$
103,560

 
$
16,377,402

Special mention
111,911

 

 
13,090

 
30,585

 
3

 
334

 
155,923

Substandard-accruing
46,731

 

 
281

 
3,837

 
227

 
4,951

 
56,027

Non-accrual
138,657

 

 
16,668

 
19,312

 

 
5,151

 
179,788

Total loans held for investment
$
6,672,631

 
$
4,966,276

 
$
1,851,717

 
$
3,139,197

 
$
25,323

 
$
113,996

 
$
16,769,140


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Table of Contents


The following table details activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2016 and September 30, 2015. 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, 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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Commercial
 
Mortgage
Finance
 
Construction
 
Real
Estate
 
Consumer
 
Leases
 
Additional Qualitative Reserve
 
Total
Beginning balance
$
70,654

 
$

 
$
7,935

 
$
15,582

 
$
240

 
$
1,141

 
$
5,402

 
$
100,954

Provision for loan losses
48,689

 

 
(3,944
)
 
(4,328
)
 
154

 
(221
)
 
(1,622
)
 
38,728

Charge-offs
11,278

 

 

 
346

 
62

 
25

 

 
11,711

Recoveries
2,098

 

 
397

 
28

 
19

 
27

 

 
2,569

Net charge-offs (recoveries)
9,180

 

 
(397
)
 
318

 
43

 
(2
)
 

 
9,142

Ending balance
$
110,163

 
$

 
$
4,388

 
$
10,936

 
$
351

 
$
922

 
$
3,780

 
$
130,540

Period end amount allocated to:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$
9,304

 
$

 
$

 
$
254

 
$

 
$
1

 
$

 
$
9,559

Loans collectively evaluated for impairment
100,859

 

 
4,388

 
10,682

 
351

 
921

 
3,780

 
120,981

Ending balance
$
110,163

 
$

 
$
4,388

 
$
10,936

 
$
351

 
$
922

 
$
3,780

 
$
130,540

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. We believe the level of additional qualitative reserve at September 30, 2016 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 weakness in the economy and continued volatility in the energy sector.


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Table of Contents

Our recorded investment in loans as of September 30, 2016December 31, 2015 and September 30, 2015 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, 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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Loans individually evaluated for impairment
$
140,479

 
$

 
$
16,668

 
$
21,042

 
$

 
$
5,151

 
$
183,340

Loans collectively evaluated for impairment
6,532,152

 
4,966,276

 
1,835,049

 
3,118,155

 
25,323

 
108,845

 
16,585,800

Total
$
6,672,631

 
$
4,966,276

 
$
1,851,717

 
$
3,139,197

 
$
25,323

 
$
113,996

 
$
16,769,140

 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
Finance
 
Construction
 
Real Estate
 
Consumer
 
Leases
 
Total
Loans individually evaluated for impairment
$
82,050

 
$

 
$
16,749

 
$
9,895

 
$

 
$
5,699

 
$
114,393

Loans collectively evaluated for impairment
6,471,589

 
4,312,790

 
1,847,429

 
3,048,679

 
24,757

 
112,945

 
15,818,189

Total
$
6,553,639

 
$
4,312,790

 
$
1,864,178

 
$
3,058,574

 
$
24,757

 
$
118,644

 
$
15,932,582


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, 2016, $816,000 of our non-accrual loans were earning on a cash basis compared to $884,000 at December 31, 2015. 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.

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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 ("ASC 310"), we have also included all restructured loans in our impaired loan totals. The following tables detail our impaired loans, by portfolio class, as of September 30, 2016 and December 31, 2015 (in thousands):
September 30, 2016
 
 
 
 
 
 
 
 
 
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
15,615

 
$
18,839

 
$

 
$
10,359

 
$

Energy
61,339

 
71,100

 

 
53,274

 

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
3,704

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Commercial
2,087

 
2,087

 

 
5,282

 
28

Secured by 1-4 family

 

 

 

 

Consumer

 

 

 

 

Leases

 

 

 
537

 

Total impaired loans with no allowance recorded
$
79,041

 
$
92,026

 
$

 
$
73,156

 
$
28

With an allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
23,079

 
$
23,154

 
$
9,516

 
$
22,207

 
$

Energy
67,981

 
72,535

 
33,158

 
74,770

 
18

Construction
 
 
 
 
 
 
 
 
 
Market risk
159

 
159

 
24

 
18

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
1,366

 
1,366

 
20

 
3,548

 

Commercial

 

 

 

 

Secured by 1-4 family
334

 
334

 
116

 
469

 

Consumer
200

 
200

 
30

 
22

 

Leases

 

 

 
722

 

Total impaired loans with an allowance recorded
$
93,119

 
$
97,748

 
$
42,864

 
$
101,756

 
$
18

Combined:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
38,694

 
$
41,993

 
$
9,516

 
$
32,566

 
$

Energy
129,320

 
143,635

 
33,158

 
128,044

 
18

Construction
 
 
 
 
 
 
 
 
 
Market risk
159

 
159

 
24

 
3,722

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
1,366

 
1,366

 
20

 
3,548

 

Commercial
2,087

 
2,087

 

 
5,282

 
28

Secured by 1-4 family
334

 
334

 
116

 
469

 

Consumer
200

 
200

 
30

 
22

 

Leases

 

 

 
1,259

 

Total impaired loans
$
172,160

 
$
189,774

 
$
42,864

 
$
174,912

 
$
46


15

Table of Contents

December 31, 2015
 
 
 
 
 
 
 
 
 
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
11,097

 
$
13,529

 
$

 
$
17,311

 
$

Energy
37,968

 
37,968

 

 
21,791

 
36

Construction
 
 
 
 
 
 
 
 
 
Market risk
16,668

 
16,668

 

 
9,764

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk

 

 

 
3,352

 

Commercial
15,353

 
15,353

 

 
4,364

 
24

Secured by 1-4 family

 

 

 

 

Consumer

 

 

 

 

Leases
2,417

 
2,417

 

 
3,233

 

Total impaired loans with no allowance recorded
$
83,503

 
$
85,935

 
$

 
$
59,815

 
$
60

With an allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
20,983

 
$
25,300

 
$
5,737

 
$
31,131

 
$

Energy
70,431

 
70,431

 
14,103

 
6,641

 

Construction
 
 
 
 
 
 
 
 
 
Market risk

 

 

 

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
5,335

 
5,335

 
1,066

 
2,558

 

Commercial

 

 

 
306

 

Secured by 1-4 family
354

 
354

 
125

 
1,580

 

Consumer

 

 

 
10

 

Leases
2,734

 
2,734

 
2,436

 
302

 

Total impaired loans with an allowance recorded
$
99,837

 
$
104,154

 
$
23,467

 
$
42,528

 
$

Combined:
 
 
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
 
 
Business loans
$
32,080

 
$
38,829

 
$
5,737

 
$
48,442

 
$

Energy
108,399

 
108,399

 
14,103

 
28,432

 
36

Construction
 
 
 
 
 
 
 
 
 
Market risk
16,668

 
16,668

 

 
9,764

 

Real estate
 
 
 
 
 
 
 
 
 
Market risk
5,335

 
5,335

 
1,066

 
5,910

 

Commercial
15,353

 
15,353

 

 
4,670

 
24

Secured by 1-4 family
354

 
354

 
125

 
1,580

 

Consumer

 

 

 
10

 

Leases
5,151

 
5,151

 
2,436

 
3,535

 

Total impaired loans
$
183,340

 
$
190,089

 
$
23,467

 
$
102,343

 
$
60



16

Table of Contents

Average impaired loans outstanding during the nine months ended September 30, 2016 and 2015 totaled $174.9 million and $90.7 million, respectively.
The table below provides an age analysis of our loans held for investment as of September 30, 2016 (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
$
37,993

 
$
14,827

 
$
9,593

 
$
62,413

 
$
37,013

 
$
6,012,367

 
$
6,111,793

Energy
1,179

 

 

 
1,179

 
129,320

 
811,687

 
942,186

Mortgage finance loans

 

 

 

 

 
4,961,159

 
4,961,159

Construction
 
 
 
 
 
 
 
 
 
 
 
 
 
Market risk
14,015

 
334

 

 
14,349

 
159

 
2,125,683

 
2,140,191

Secured by 1-4 family
1,063

 

 

 
1,063

 

 
9,199

 
10,262

Real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Market risk

 
639

 

 
639

 

 
2,548,337

 
2,548,976

Commercial

 

 

 

 
2,087

 
654,029

 
656,116

Secured by 1-4 family
382

 
47

 
107

 
536

 
334

 
185,869

 
186,739

Consumer

 
7

 
6

 
13

 
200

 
27,341

 
27,554

Leases
41

 

 

 
41

 

 
96,837

 
96,878

Total loans held for investment
$
54,673

 
$
15,854

 
$
9,706

 
$
80,233

 
$
169,113

 
$
17,432,508

 
$
17,681,854

 
(1)
Loans past due 90 days and still accruing includes premium finance loans of $7.1 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, 2016, we did not have any loans considered restructured that were not on non-accrual compared to $249,000 at December 31, 2015. These loans did not have unfunded commitments at September 30, 2016 or December 31, 2015. Of the non-accrual loans at September 30, 2016 and December 31, 2015, $19.7 million and $24.9 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.

17

Table of Contents

The following tables summarize, for the nine months ended September 30, 2016 and 2015, loans that were restructured during 2016 and 2015 (in thousands):
 
September 30, 2016
 
 
 
 
 
 
Number of Restructured Loans
 
Pre-Restructuring Outstanding Recorded Investment
 
Post-Restructuring Outstanding Recorded Investment
Energy loans
2

 
$
14,235

 
$
13,289

Commercial business loans

 
$

 
$

Real estate - market risk

 
$

 
$

Total new restructured loans in 2016
2

 
$
14,235

 
$
13,289

 
 
 
 
 
 
September 30, 2015
 
 
 
 
 
 
Number of Restructured Loans
 
Pre-Restructuring Outstanding Recorded Investment
 
Post-Restructuring Outstanding Recorded Investment
Commercial business loans
5

 
$
20,459

 
$
15,438

Total new restructured loans in 2015
5

 
$
20,459

 
$
15,438

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, 2016 or 2015.
The following table provides information on how restructured loans were modified during the nine months ended September 30, 2016 and 2015 (in thousands):
 
 
Nine months ended September 30,
 
2016
 
2015
Extended maturity
$

 
$

Adjusted payment schedule
12,647

 

Combination of maturity extension and payment schedule adjustment
642

 
15,438

Total
$
13,289

 
$
15,438

As of September 30, 2016 and 2015, 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,
 
2016
 
2015
 
2016
 
2015
Beginning balance
$
18,727

 
$
609

 
$
278

 
$
568

Additions
282

 

 
18,822

 
1,177

Sales

 
(422
)
 
(91
)
 
(1,558
)
Valuation allowance for OREO

 

 

 

Direct write-downs

 

 

 

Ending balance
$
19,009

 
$
187

 
$
19,009

 
$
187

The addition to OREO during the nine months ended September 30, 2016 relates to the foreclosure of three commercial properties.


18



(6) CERTAIN TRANSFERS OF FINANCIAL ASSETS
Through our Mortgage Correspondent Aggregation ("MCA") business, we commit to purchase residential mortgage loans from correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to government sponsored entities ("GSEs") such as Fannie Mae, Freddie Mac or Ginnie Mae. We have elected to carry these loans at fair value based on sales commitments and market quotes. Changes in the fair value of the loans held for sale are included in other non-interest income.
Residential mortgage loans 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 managed 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, 2016 and December 31, 2015 (in thousands):
 
September 30, 2016
 
December 31, 2015
Unpaid principal balance
$
620,207

 
$
82,853

Fair value
648,684

 
86,075

Fair value over/(under) unpaid principal balance
$
28,477

 
$
3,222

No loans held for sale were 90 days or more past due or on non-accrual as of September 30, 2016 and December 31, 2015.
The differences between the fair value and the aggregate unpaid principal balance include changes in fair value recorded at and subsequent to purchase, gains and losses on the related loan purchase commitment prior to purchase and premiums or discounts on acquired loans.
We generally retain the right to service the loans sold, creating mortgage servicing rights ("MSRs") which are recorded as assets on our balance sheet. A summary of MSR activities for the nine months ended September 30, 2016 is as follows (in thousands):
Servicing asset:
 
    Balance, beginning of year(1)
$
423

    Capitalized servicing rights
16,344

    Amortization
(891
)
Balance, end of period
$
15,876

Valuation allowance:
 
    Balance, beginning of year
$

    Increase in valuation allowance
414

Balance, end of period
$
414

Servicing asset, net(1)
$
15,462

Fair value
$
15,970

(1)
Mortgage servicing rights are reported on the consolidated balance sheets at lower of cost or market. Carrying value and fair value were the same at December 31, 2015, respectively.
At September 30, 2016 and December 31, 2015, our servicing portfolio of residential mortgage loans sold included 4,954 and 168 loans, respectively, with an outstanding principal balance of $1.3 billion and $39.0 million, respectively. In connection with the servicing of these loans, we maintain 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 $18.5 million at September 30, 2016 and $240,000 at December 31, 2015.

19



As of September 30, 2016 and December 31, 2015, management used the following assumptions to determine the fair value of MSRs:
 
September 30, 2016
December 31, 2015
Average discount rates
10.09
%
9.76
%
Expected prepayment speeds
11.18
%
9.66
%
Weighted average life, in years
6.5

7.3

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. During the nine months ended September 30, 2016, we originated or purchased and sold approximately $1.4 billion of mortgage loans.
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 will include 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 no 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 from September 2015 through September 30, 2016. The historical industry data loss factors and experienced losses are accumulated for each sale vintage (year loan was sold) and applied to more recent sale vintages to estimate inherent losses not yet realized. Our estimated exposure related to these loans was $621,000 at September 30, 2016 and is recorded in other liabilities in the consolidated balance sheets. We had no losses due to repurchase, indemnification or make-whole obligations during the nine months ended September 30, 2016 as it relates to our MCA program.
(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, 2016
 
December 31, 2015
Commitments to extend credit
$
5,604,322

 
$
5,542,363

Standby letters of credit
179,447

 
182,219

(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

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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 applicable to the Company and the Bank (the "Basel III Capital Rules") specifies, among other things, (i) a "Common Equity Tier 1" ("CET1") capital measure, (ii) a Tier 1 capital measure consisting of CET1 and "Additional Tier 1 Capital" instruments meeting specified requirements, (iii) capital conservation buffers with respect to each of the CET1, Tier 1 risk-based and total risk-based capital ratios providing for capital levels that exceed the minimum risk-based capital adequacy requirements and (iv) a Tier 1 leverage ratio requirement of 5.0%.
In order to be well capitalized under the Basel III Capital Rules, our Bank must maintain a CET1 capital ratio, Tier 1 capital ratio and total capital ratio of greater than or equal to 6.5%, 8.0% and 10.0%, respectively. The capital conservation buffers required by the Basel III Capital Rules are 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%. A financial institution with a conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments and stock repurchases and executive bonus payments.
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, 2016, 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, 2016, and December 31, 2015. Based upon the information in its most recently filed call report, the Bank met the capital ratios necessary to be well capitalized. The regulatory authorities can apply changes in classification of assets and such changes may retroactively subject the Company to changes in capital ratios. Any such changes could result in reducing one or more capital ratios below well-capitalized status. In addition, a change may result in imposition of additional assessments by the FDIC or could result in regulatory actions that could have a material adverse effect on our financial condition and results of operations.
Because our Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, we are allowed to continue to classify our trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital.
The table below summarizes our capital ratios: 
 
September 30,
2016
 
December 31,
2015
Company
 
 
 
Risk-based capital:
 
 
 
CET1
7.55
%
 
7.47
%
Tier 1 capital
8.80
%
 
8.81
%
Total capital
11.09
%
 
11.05
%
Tier 1 leverage
8.38
%
 
8.92
%
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, 2016, our total mortgage finance loans were $5.0 billion compared to the average for the quarter ended September 30, 2016 of $4.7 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 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

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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, 2016 or 2015.
(9) STOCK-BASED COMPENSATION
We have stock-based compensation plans under which equity-based compensation grants are made by the board of directors, or its designated committee. Grants are subject to vesting requirements. Under the plans, we may grant, among other things, nonqualified stock options, incentive stock options, restricted stock units ("RSUs"), stock appreciation rights ("SARs"), cash-based performance units or any combination thereof. Plans include grants for employees and directors. There are 2,550,000 total shares authorized under the plans.
The fair value of our option and stock appreciation right ("SAR") grants are estimated at the date of grant using the Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide the best single measure of the fair value of employee stock options.
Stock-based compensation consists of SARs, RSUs and cash-based performance units granted from 2010 through September 30, 2016.
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Stock- based compensation expense recognized:
 
 
 
 
 
 
 
SARs
$
74

 
$
85

 
$
233

 
$
282

RSUs
1,149

 
1,140

 
3,233

 
3,046

       Cash-based performance units
1,227

 
1,420

 
2,709

 
5,958

Total compensation expense recognized
$
2,450

 
$
2,645

 
$
6,175

 
$
9,286

 
 
September 30, 2016
(in thousands)
SARs and
RSUs
Unrecognized compensation expense related to unvested awards
$
17,378

Weighted average period over which expense is expected to be recognized, in years
3.3


(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

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bonds, and Community Reinvestment Act funds. This category includes loans held for sale and derivative assets and liabilities where values are obtained from independent pricing services.
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 also includes impaired loans, MSRs and OREO where collateral values have been based on third party appraisals; however, due to current economic conditions, comparative sales data typically used in appraisals may be unavailable or more subjective due to lack of market activity.

Assets and liabilities measured at fair value at September 30, 2016 and December 31, 2015 are as follows (in thousands):
 
Fair Value Measurements Using
September 30, 2016
Level 1
 
Level 2
 
Level 3
Available-for-sale securities:(1)
 
 
 
 
 
Residential mortgage-backed securities
$

 
$
17,146

 
$

Municipals

 
566

 

Equity securities(2)
1,300

 
7,344

 

Loans held for sale (3)

 
648,684

 

Loans held for investment(4) (6)

 

 
36,449

OREO(5) (6)

 

 
19,009

Derivative assets(7)

 
58,158

 

Derivative liabilities(7)

 
60,548

 

Non-qualified deferred compensation plan liabilities (8)
1,300

 

 

 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
Available-for-sale securities:(1)
 
 
 
 
 
Residential mortgage-backed securities
$

 
$
21,901

 
$

Municipals

 
831

 

Equity securities(2)

 
7,260

 

Loans held for sale(3)

 
86,075

 

Loans(4) (6)

 

 
41,420

OREO(5) (6)

 

 
278

Derivative assets(7)

 
35,292

 

Derivative liabilities(7)

 
35,420

 

 
(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 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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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 also include those for which the determination of fair value requires significant management judgment or estimation. Currently, we measure the fair value for certain loans and OREO on a nonrecurring basis as described below.
Loans held for investment
During the nine months ended September 30, 2016 and the year ended December 31, 2015, certain impaired loans held for investment were re-evaluated and reported at fair value through a specific allocation of the allowance for loan losses based upon the fair value of the underlying collateral. The $36.4 million reported fair value above includes impaired loans held for investment at September 30, 2016 with a carrying value of $61.7 million that were reduced by specific allowance allocations totaling $25.3 million based on collateral valuations utilizing Level 3 valuation inputs. The $41.4 million reported fair value above includes impaired loans held for investment at December 31, 2015 with a carrying value of $49.7 million that were reduced by specific valuation allowance allocations totaling $8.3 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, 2016 and December 31, 2015, OREO had a carrying value of $19.0 million and $278,000, respectively, with no specific valuation allowance. The fair value of OREO was computed based on third party appraisals, which are Level 3 valuation inputs.
Fair Value of Financial Instruments
GAAP require disclosure of fair value information about financial instruments, whether or not recognized on the balance sheet, for which it is practical to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. This disclosure does not and is not intended to represent the fair value of the Company.
A summary of the carrying amounts and estimated fair values of financial instruments is as follows (in thousands):
 
 
September 30, 2016
 
December 31, 2015
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Cash and cash equivalents
$
3,588,419

 
$
3,588,419

 
$
1,790,870

 
$
1,790,870

Securities, available-for-sale
26,356

 
26,356

 
29,992

 
29,992

Loans held for sale
648,684

 
648,684

 
86,075

 
86,075

Loans held for investment, net
17,443,117

 
17,445,311

 
16,570,839

 
16,576,297

Derivative assets
58,158

 
58,158

 
35,292

 
35,292

Deposits
18,145,123

 
18,145,619

 
15,084,619

 
15,085,080

Federal funds purchased
73,768

 
73,768

 
74,164

 
74,164

Customer repurchase agreements
7,652

 
7,652

 
68,887

 
68,887

Other borrowings
1,670,000

 
1,670,000

 
1,500,000

 
1,500,000

Subordinated notes
280,954

 
284,230

 
280,682

 
285,773

Trust preferred subordinated debentures
113,406

 
113,406

 
113,406

 
113,406

Derivative liabilities
60,548

 
60,548

 
35,420

 
35,420

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.



24

Table of Contents

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 valued under the fair value option 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.
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 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 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. Fixed-term certificates of deposit fair values 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 assets 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 and 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, 2016 and 2015, 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

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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, 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.
The notional amounts and estimated fair values of interest rate derivative positions outstanding at September 30, 2016 and December 31, 2015 are presented in the following tables (in thousands):
 
 
September 30, 2016
 
December 31, 2015
 
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
$
1,070,684

 
$

 
$
56,503

 
$
976,389

 
$

 
$
33,851

Commercial loan/lease interest rate caps
211,854

 
230

 

 
194,304

 
1,441

 

Customer counterparties:
 
 
 
 
 
 
 
 
 
 
 
Commercial loan/lease interest rate swaps
1,070,684

 
56,503

 

 
976,389

 
33,851

 

Commercial loan/lease interest rate caps
211,854

 

 
230

 
194,304

 

 
1,441

Economic hedging interest rate derivatives:
 
 
 
 
 
 
 
 
 
 
 
Loan purchase commitments
310,534

 
1,425

 

 
62,835

 

 
109

Forward sales commitments
941,963

 

 
3,815

 
143,200

 

 
19

Gross derivatives
 
 
58,158

 
60,548

 
 
 
35,292

 
35,420

Offsetting derivative assets/liabilities
 
 

 

 
 
 

 

Net derivatives included in the consolidated balance sheets
 
 
$
58,158

 
$
60,548

 
 
 
$
35,292

 
$
35,420

The weighted average received and paid interest rates for interest rate swaps outstanding at September 30, 2016 and December 31, 2015 were as follows:
 
 
September 30, 2016
Weighted Average Interest Rate
 
December 31, 2015
Weighted Average Interest Rate
 
Received
 
Paid
 
Received
 
Paid
Non-hedging interest rate swaps
3.00
%
 
4.61
%
 
2.96
%
 
4.72
%
The weighted average strike rate for outstanding interest rate caps was 2.45% at September 30, 2016 and 2.34% at December 31, 2015.
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 $58.2 million at September 30, 2016 and approximately $35.3 million at December 31, 2015, which primarily relates to Bank customers. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap and cap values. At September 30, 2016, we had $65.5 million in cash collateral pledged for these derivatives, of which $62.1 million was included in interest-bearing deposits and $3.4 million was included in accrued interest receivable and other assets. At December 31, 2015, we had $37.1 million in cash collateral pledged for these derivatives, all of which was included in interest-bearing deposits.

26



(12) NEW ACCOUNTING PRONOUNCEMENTS
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 is effective for public companies for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted with retrospective application. We are evaluating the impact adoption of ASU 2016-15 will have 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. ASU 2016-13 is effective for public companies for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. 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. We are in the process of evaluating the impact adoption of ASU 2016-13 will have on our consolidated financial statements and disclosures.
ASU 2016-09 "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payments Accounting" ("ASU 2016-09") amended guidance with the intent to simplify accounting for share-based payment transaction, including the income tax consequences and classification of awards. Among other items, the update requires excess tax benefits and deficiencies to be recognized as a component of income taxes within the income statement rather than other comprehensive income as required in current guidance. ASU 2016-09 is effective for public companies for annual periods beginning after December 31, 2016 and is not expected to have a significant impact on our financial statements.
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 is effective for public companies for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. We have not yet selected a transition method as we are in the process of determining the effect of the standard on our financial statements and disclosures.
ASU 2015-03 "Interest - Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs" ("ASU 2015-03") requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Prior to the issuance of ASU 2015-03, debt issuance costs were required to be presented as deferred charge assets, separate from the related debt liability. ASU 2015-03 does not change the recognition and measurement requirements for debt issuance costs. We adopted ASU 2015-03 effective January 1, 2016 and applied its provisions retrospectively. The adoption of ASU 2015-03 resulted in the reclassification of $5.0 million and $5.3 million of unamortized debt issuance costs related to our subordinated notes from other assets to subordinated notes within the consolidated balance sheets as of September 30, 2016 and December 31, 2015, respectively. Other than this reclassification, the adoption of ASU 2015-03 did not have a material impact on our consolidated financial statements.
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. ASU 2014-09 was originally going to be effective for annual and interim periods beginning after December 15, 2016; however, the FASB issued ASU 2015-14 - "Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date" which deferred the effective date of ASU 2014-09 by one year to annual and interim periods beginning after December 15, 2017. We are in the process of evaluating the impact adoption of ASU 2014-09 will have on our consolidated financial statements and disclosures.

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

 
For the three months ended 
 September 30, 2016
 
For the three months ended 
 September 30, 2015
 
Average
Balance
 
Revenue/
Expense(1)
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense(1)
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Securities – taxable
$
26,051

 
$
228

 
3.47
%
 
$
32,358

 
$
287

 
3.52
%
Securities – non-taxable(2)
564

 
8

 
5.82
%
 
1,162

 
17

 
5.80
%
Federal funds sold and securities purchased under resale agreements
369,215

 
455

 
0.49
%
 
308,822

 
193

 
0.25
%
Deposits in other banks
3,192,141

 
4,080

 
0.51
%
 
2,537,033

 
1,616

 
0.25
%
Loans held for sale
430,869

 
3,662

 
3.38
%
 
570

 
6

 
4.18

Loans held for investment, mortgage finance
4,658,804

 
36,655

 
3.13
%
 
3,981,731

 
30,427

 
3.03
%
Loans held for investment
12,591,561

 
137,407

 
4.34
%
 
11,302,248

 
121,316

 
4.26
%
Less allowance for loan losses
168,086

 

 

 
118,543

 

 

Loans held for investment, net of allowance for loan losses
17,082,279

 
174,062

 
4.05
%
 
15,165,436

 
151,743

 
3.97
%
Total earning assets
21,101,119

 
182,495

 
3.44
%
 
18,045,381

 
153,862

 
3.38
%
Cash and other assets
588,440

 
 
 
 
 
481,378

 
 
 
 
Total assets
$
21,689,559

 
 
 
 
 
$
18,526,759

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
$
2,301,362

 
$
1,960

 
0.34
%
 
$
1,754,940

 
$
763

 
0.17
%
Savings deposits
6,177,681

 
6,228

 
0.40
%
 
5,858,381

 
4,616

 
0.31
%
Time deposits
501,701

 
763

 
0.61
%
 
536,531

 
723

 
0.53
%
Deposits in foreign branches

 

 
%
 
179,731

 
138

 
0.30
%
Total interest-bearing deposits
8,980,744

 
8,951

 
0.40
%
 
8,329,583

 
6,240

 
0.30
%
Other borrowings
1,607,613

 
1,860

 
0.46
%
 
1,459,864

 
734

 
0.20
%
Subordinated notes
280,895

 
4,191

 
5.94
%
 
280,532

 
4,191

 
5.93
%
Trust preferred subordinated debentures
113,406

 
752

 
2.64
%
 
113,406

 
643

 
2.25
%
Total interest-bearing liabilities
10,982,658

 
15,754

 
0.57
%
 
10,183,385

 
11,808

 
0.46
%
Demand deposits
8,849,725

 
 
 
 
 
6,621,159

 
 
 
 
Other liabilities
135,141

 
 
 
 
 
152,154

 
 
 
 
Stockholders’ equity
1,722,035

 
 
 
 
 
1,570,061

 
 
 
 
Total liabilities and stockholders’ equity
$
21,689,559

 
 
 
 
 
$
18,526,759

 
 
 
 
Net interest income(2)
 
 
$
166,741

 
 
 
 
 
$
142,054

 
 
Net interest margin
 
 
 
 
3.14
%
 
 
 
 
 
3.12
%
Net interest spread
 
 
 
 
2.87
%
 
 
 
 
 
2.92
%
Loans held for investment spread
 
 
 
 
3.83
%
 
 
 
 
 
3.80
%
 
(1)
The loan averages include non-accrual loans and are stated net of unearned income.
(2)
Taxable equivalent rates used where applicable.

 
 
 
 
 
 
 
 
 
 
 
 
 
For the nine months ended
September 30, 2016
 
For the nine months ended
September 30, 2015
 
Average
Balance
 
Revenue/
Expense(1)
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense(1)
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Securities – taxable
$
27,160

 
$
722

 
3.55
%
 
$
34,844

 
$
930

 
3.57
%
Securities – non-taxable(2)
629

 
27

 
5.74
%
 
1,785

 
75

 
5.62
%
Federal funds sold and securities purchased under resale agreements
328,971

 
1,209

 
0.49
%
 
234,033

 
427

 
0.24
%
Deposits in other banks
2,905,251

 
11,115

 
0.51
%
 
2,222,006

 
4,203

 
0.25
%
Loans held for sale
238,987

 
6,106

 
3.41
%
 
192

 
6

 
4.18
%
Loans held for investment, mortgage finance
4,266,573

 
99,666

 
3.12
%
 
4,101,576

 
91,831

 
2.99
%
Loans held for investment
12,260,752

 
395,901

 
4.31
%
 
10,918,080

 
350,692

 
4.29
%
Less allowance for loan losses
157,880

 

 

 
109,621

 

 

Loans held for investment, net of allowance for loan losses
16,369,445

 
495,567

 
4.04
%
 
14,910,035

 
442,523

 
3.97
%
Total earning assets
19,870,443

 
514,746

 
3.46
%
 
17,402,895

 
448,164

 
3.44
%
Cash and other assets
546,553

 
 
 
 
 
474,181

 
 
 
 
Total assets
$
20,416,996

 
 
 
 
 
$
17,877,076

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
$
2,171,776

 
$
5,085

 
0.31
%
 
$
1,521,657

 
$
1,665

 
0.15
%
Savings deposits
6,299,965

 
19,441

 
0.41
%
 
5,786,547

 
13,368

 
0.31
%
Time deposits
499,366

 
2,217

 
0.59
%
 
500,590

 
1,886

 
0.50
%
Deposits in foreign branches

 

 
%
 
242,874

 
591

 
0.33
%
Total interest-bearing deposits
8,971,107

 
26,743

 
0.40
%
 
8,051,668

 
17,510

 
0.29
%
Other borrowings
1,455,888

 
4,628

 
0.25
%
 
1,400,523

 
1,821

 
0.17
%
Subordinated notes
280,805

 
12,573

 
5.98
%
 
280,442

 
12,573

 
5.99
%
Trust preferred subordinated debentures
113,406

 
2,203

 
2.59
%
 
113,406

 
1,892

 
2.23
%
Total interest bearing liabilities
10,821,206

 
46,147

 
0.55
%
 
9,846,039

 
33,796

 
0.46
%
Demand deposits
7,786,562

 
 
 
 
 
6,343,195

 
 
 
 
Other liabilities
132,506

 
 
 
 
 
155,466

 
 
 
 
Stockholders’ equity
1,676,722

 
 
 
 
 
1,532,376

 
 
 
 
Total liabilities and stockholders’ equity
$
20,416,996

 
 
 
 
 
$
17,877,076

 
 
 
 
Net interest income(2)
 
 
$
468,599

 
 
 
 
 
$
414,368

 
 
Net interest margin
 
 
 
 
3.15
%
 
 
 
 
 
3.18
%
Net interest spread
 
 
 
 
2.91
%
 
 
 
 
 
2.98
%
Loans held for investment spread
 
 
 
 
3.82
%
 
 
 
 
 
3.80
%

(1)
The loan averages include non-accrual loans and are stated net of unearned income.
(2)
Taxable equivalent rates used where applicable.


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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Certain statements and financial analysis contained in this report that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of federal securities laws. Forward-looking statements may also be contained in our future filings with SEC, in press releases and in oral and written statements made by us or with our approval that are not statements of historical fact. These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. Words such as “believes,” “expects,” “estimates,” “anticipates,” “plans,” “goals,” “objectives,” “expects,” “intends,” “seeks,” “likely,” “targeted,” “continue,” “remain,” “will,” “should,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements may include, among other things, statements about the credit quality of our loan portfolio, economic conditions, including the continued impact on our customers from declines and volatility in oil and gas prices, expectations regarding rates of default or loan losses, volatility in the mortgage industry, our business strategies and our expectations about future financial performance, future growth and earnings, the appropriateness of our allowance for loan losses and provision for credit losses, the impact of increased regulatory requirements on our business, increased competition, interest rate risk, new lines of business, new product or service offerings and new technologies.
Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management’s expectations and assumptions at the time the statements are made and are not guarantees of future results. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, the following:
Deterioration of the credit quality of our loan portfolio or declines in the value of collateral related to external factors such as commodity prices or interest rates, increased default rates and loan losses or adverse changes in the industry concentrations of our loan portfolio.
Changes in the U.S. economy in general or the Texas economy specifically resulting in deterioration of credit quality or reduced demand for credit or other financial services we offer, including declines and volatility in oil and gas prices.
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 decreases in loan quality and increases in charge-offs.
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 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.
The failure to successfully expand into new markets, develop and launch 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.
The failure to manage our information systems risk or to prevent cyber attacks against us or our third party vendors.
Legislative and regulatory changes imposing further restrictions and costs on our business, a failure to remain well capitalized or well managed or regulatory enforcement actions against us.
Adverse changes in economic or business conditions that impact the financial markets or our customers.

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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 mortgage servicing rights ("MSRs") related to these loans and related interest rate and market risk resulting from retaining MSRs.
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.
An increase in the incidence or severity of fraud, illegal payments, security breaches and other illegal acts impacting our Bank and our customers.
Structural changes in the markets for origination, sale and servicing of residential mortgages.
Unavailability of funds obtained from capital transactions or from our Bank to fund our obligations.
Failures of counterparties or third party vendors to perform their obligations.
Environmental liability associated with properties related to our lending activities.
Severe weather, natural disasters, acts of war or terrorism and other external events.
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.
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. 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.
In the third quarter of 2015, we launched a correspondent lending program, MCA, to complement our warehouse lending program. Through our MCA program we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to GSEs such as Fannie Mae, Freddie Mac and Ginnie Mae. We retain the MSRs in some cases with the expectation that they will be sold from time to time. Once purchased, these loans are classified as held for sale and are carried at fair value pursuant to our election of the fair value option. At the commitment date, we enter into a corresponding forward sale commitment with a third party, typically a GSE, to deliver the loans to the third party within a specified timeframe. The estimated gain/loss for the entire transaction (from initial purchase commitment to final delivery of loans) is recorded as an asset or liability. Fair value is derived from observable current market prices, when available, and includes the fair value of the MSRs. At September 30, 2016 and December 31, 2015, we had $648.7 million and $86.1 million in loans held for sale related to MCA.
The following discussion and analysis presents the significant factors affecting our financial condition as of September 30, 2016 and December 31, 2015 and results of operations for the three and nine months in the periods ended September 30, 2016 and 2015. 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.

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Results of Operations
Summary of Performance
We reported 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 compared to net income of $37.1 million and net income available to common stockholders of $34.7 million, or $0.75 per diluted common share, for the third quarter of 2015. Return on average common equity (“ROE”) was 10.20% and return on average assets ("ROA") was 0.78% for the third quarter of 2016, compared to 9.69% and 0.79%, respectively, for the third quarter of 2015. The increase in ROE resulted from an increase in net interest income for the third quarter of 2016, despite a higher provision for credit losses. ROA remains low as a result of the increased provision for credit losses and higher liquidity assets. Net income and net income available to common stockholders for the nine months ended September 30, 2016 totaled $106.7 million and $99.4 million, respectively, or $2.14 per diluted common share, compared to net income and net income available to common stockholders of $110.1 million and $102.8 million, respectively, or $2.21 per diluted common share, for the same period in 2015. ROE was 8.70% and ROA was 0.70% for the nine months ended September 30, 2016 compared to 9.94% and 0.82%, respectively, for the nine months ended September 30, 2015. The ROE decrease resulted from the increased provision for credit losses. The ROA decrease resulted from the increased provision for credit losses, as well as a $778.2 million increase in average liquidity assets during the nine months ended September 30, 2016 compared to the same period of 2015.
Net income increased $5.6 million, or 15%, for the three months ended September 30, 2016, as compared to the same period in 2015. The increase was primarily the result of a $24.7 million increase in net interest income and a $5.3 million increase in non-interest income, offset by an $8.3 million increase in the provision for credit losses, a $13.1 million increase in non-interest expense and a $3.1 million increase in income tax expense. Net income decreased $3.4 million or 3%, during the nine months ended September 30, 2016 compared to the same period in 2015, primarily as a result of a $54.2 million increase in net interest income, a $5.5 million increase in non-interest income and a $2.0 million decrease in income tax expense, offset by a $28.8 million increase in the provision for credit losses and a $36.4 million increase in non-interest expense.
Details of the changes in the various components of net income are discussed below.

Net Interest Income
Net interest income was $166.7 million for the third quarter of 2016, compared to $142.0 million for the third quarter of 2015. The increase was due to an increase in average earning assets of $3.1 billion as compared to the third quarter of 2015. The increase in average earning assets included a $1.9 billion increase in average net loans and a $715.5 million increase in average liquidity assets, offset by a $6.9 million decrease in average securities. For the quarter ended September 30, 2016, average net loans, liquidity assets and securities represented approximately 81%, 17% and less than 1%, respectively, of average earning assets compared to approximately 84%, 16% and less than 1% for the same quarter of 2015.
Average interest-bearing liabilities for the quarter ended September 30, 2016 increased $799.3 million from the third quarter of 2015, which included a $651.2 million increase in interest-bearing deposits offset by a $147.7 million decrease in other borrowings. Average demand deposits increased from $6.6 billion at September 30, 2015 to $8.8 billion at September 30, 2016. The average cost of total deposits and borrowed funds increased to 0.22% for the third quarter of 2016 compared to 0.17% for the same period of 2015. The cost of interest-bearing liabilities increased from 0.46% for the quarter ended September 30, 2015 to 0.57% for the same period of 2016.
Net interest income was $468.6 million for the nine months ended September 30, 2016, compared to $414.3 million for the same period in 2015. The increase was due to an increase in average earning assets of $2.5 billion as compared to the nine months ended September 30, 2015. The increase in average earning assets included a $1.5 billion increase in average net loans and a $778.2 million increase in average liquidity assets, offset by an $8.8 million decrease in average securities. For the nine months ended September 30, 2016, average net loans, liquidity assets and securities represented approximately 82%, 16% and less than 1%, respectively, of average earning assets compared to approximately 86%, 14% and less than 1% for the same period of 2015.
Average interest-bearing liabilities for the nine months ended September 30, 2016 increased $975.2 million from the same period of 2015, which included a $919.4 million increase in interest-bearing deposits and a $55.4 million increase in other borrowings. Average demand deposits increased from $6.3 billion at September 30, 2015 to $7.8 billion at September 30, 2016. The average cost of total deposits and borrowed funds increased to 0.22% for the nine months ended September 30, 2016 compared to 0.16% for the same period of 2015. The cost of interest-bearing liabilities increased from 0.46% for the nine months ended September 30, 2015 to 0.55% for the same period of 2016.


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The following table (in thousands) presents changes in taxable-equivalent net interest income between the three and nine month periods ended September 30, 2016 and September 30, 2015 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, 2016/2015
 
Nine months ended
September 30, 2016/2015
 
Net
 
Change Due To(1)
 
Net
 
Change Due To(1)
 
Change
 
Volume
 
Yield/Rate
 
Change
 
Volume
 
Yield/Rate
Interest income:
 
 
 
 
 
 
 
 
 
 
 
Securities(2)
$
(68
)
 
$
(65
)
 
$
(3
)
 
$
(256
)
 
$
(253
)
 
$
(3
)
Loans held for sale
3,656

 
4,518

 
(862
)
 
6,100

 
7,466

 
(1,366
)
Loans held for investment, mortgage finance loans
6,228

 
5,092

 
1,136

 
7,835

 
3,738

 
4,097

Loans held for investment
16,091

 
13,558

 
2,533

 
45,209

 
43,478

 
1,731

Federal funds sold
262

 
38

 
224

 
782

 
173

 
609

Deposits in other banks
2,464

 
413

 
2,051

 
6,912

 
1,295

 
5,617

Total
28,633

 
23,554

 
5,079

 
66,582

 
55,897

 
10,685

Interest expense:
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
1,197

 
235

 
962

 
3,420

 
712

 
2,708

Savings deposits
1,612

 
252

 
1,360

 
6,073

 
1,189

 
4,884

Time deposits
40

 
(39
)
 
79

 
331

 
(5
)
 
336

Deposits in foreign branches
(138
)
 
(138
)
 

 
(591
)
 
(591
)
 

Borrowed funds
1,126

 
74

 
1,052

 
2,807

 
72

 
2,735

Long-term debt
109

 

 
109

 
311

 

 
311

Total
3,946

 
384

 
3,562

 
12,351

 
1,377

 
10,974

Net interest income
$
24,687

 
$
23,170

 
$
1,517

 
$
54,231

 
$
54,520

 
$
(289
)
 
(1)
Changes attributable to both volume and yield/rate are allocated to both volume and yield/rate on an equal basis.
(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 3.14% for the third quarter of 2016 compared to 3.12% for the third quarter of 2015. The year-over-year increase was primarily due to the growth in loans held for investment with higher yields. Funding costs, including demand deposits and borrowed funds, increased to 0.22% for the third quarter of 2016 compared to 0.17% for the third quarter of 2015. The spread on total earning assets, net of the cost of deposits and borrowed funds, was 3.22% for the third quarter of 2016 compared to 3.21% for the third quarter of 2015. The increase resulted primarily from the increase in earning assets and rates on earning assets. Total funding costs, including all deposits, long-term debt and stockholders’ equity, increased to 0.29% for the third quarter of 2016 compared to 0.25% for the third quarter of 2015.
Non-interest Income
The components of non-interest income were as follows (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
Service charges on deposit accounts
$
2,880

 
$
2,096

 
$
7,401

 
$
6,339

Trust fee income
1,113

 
1,222

 
3,024

 
3,709

Bank owned life insurance (BOLI) income
520

 
484

 
1,592

 
1,444

Brokered loan fees
7,581

 
4,885

 
18,090

 
14,394

Swap fees
918

 
254

 
2,330

 
3,275

Other
3,704

 
2,439

 
9,508

 
7,257

Total non-interest income
$
16,716

 
$
11,380

 
$
41,945

 
$
36,418


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Non-interest income increased $5.3 million during the three months ended September 30, 2016 compared to the same period of 2015. This increase was primarily due to a $2.7 million increase in brokered loan fees during the three months ended September 30, 2016 compared to the same period of 2015 as a result of an increase in mortgage finance and loans held for sale volumes. Service charges increased $784,000 during the three months ended September 30, 2016 compared to the same period of 2015 as a result of the increase in deposit balances and improved pricing. Swap fees increased $664,000 during the three months ended September 30, 2016 compared to the same period of 2015. Swap fees are fees related 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 number and volume of transactions closed during the quarter. Other non-interest income increased $1.3 million during the three months ended September 30, 2016 compared to the same period of 2015. Other non-interest income includes such items as letter of credit fees, other general operating income and changes in the fair value of loans held for sale, none of which account for 1% or more of total interest income and non-interest income.
Non-interest income increased $5.5 million during the nine months ended September 30, 2016 compared to the same period of 2015. This increase was primarily due to a $3.7 million increase in brokered loan fees during the nine months ended September 30, 2016 compared to the same period of 2015 as a result of an increase in mortgage finance and loans held for sale volumes. Service charges increased $1.1 million during the nine months ended September 30, 2016 compared to the same period of 2015 as a result of the increase in deposit balances and improved pricing. Other non-interest income increased $2.3 million during the nine months ended September 30, 2016 compared to the same period of 2015. Other non-interest income includes such items as letter of credit fees, other general operating income and changes in the fair value of loans held for sale, none of which account for 1% or more of total interest income and non-interest income. Offsetting these increases was a $945,000 decrease in swap fees during the nine months ended September 30, 2016 compared to the same period of 2015.
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. In order to achieve growth in non-interest income, we may need to introduce new products or enter into new lines of business or expand existing lines of business. Any new product introduction or new market entry could place additional demands on capital and managerial resources.
Non-interest Expense
The components of non-interest expense were as follows (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
Salaries and employee benefits
$
56,722

 
$
48,583

 
$
162,904

 
$
142,611

Net occupancy expense
5,634

 
5,874

 
17,284

 
17,373

Marketing
4,292

 
3,999

 
12,686

 
12,142

Legal and professional
5,333

 
5,510

 
16,883

 
15,176

Communications and technology
6,620

 
5,180

 
19,228

 
15,905

FDIC insurance assessment
6,355

 
4,489

 
17,867

 
12,490

Allowance and other carrying costs for OREO
269

 
1

 
765

 
16

Other(1)
9,574

 
8,052

 
28,257

 
23,768

Total non-interest expense
$
94,799

 
$
81,688

 
$
275,874

 
$
239,481

 
(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 2016 increased $13.1 million, or 16%, to $94.8 million from $81.7 million in the third quarter of 2015. The increase is primarily attributable to an $8.1 million increase in salaries and employee benefits expense due to general business growth and continued build-out.
Communications and technology expense for the three months ended September 30, 2016 increased $1.4 million as a result of general business and customer growth and continued build-out needed to support that growth, including investment in IT security.
FDIC insurance assessment expense for the three months ended September 30, 2016 increased $1.9 million compared to the same quarter in 2015 as a result of the increase in total assets from September 30, 2015 to September 30, 2016.

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Non-interest expense for the nine months ended September 30, 2016 increased $36.4 million, or 15%, to $275.9 million from $239.5 million for the same period of 2015. The increase is primarily attributable to a $20.3 million increase in salaries and employee benefits expense due to general business growth and continued build-out.
Legal and professional expense for the nine months ended September 30, 2016 increased $1.7 million compared to the same period of 2015. Our legal and professional expense will continue to fluctuate and could increase in the future due to additional growth and as we respond to continued regulatory changes and strategic initiatives.
Communications and technology expense for the nine months ended September 30, 2016 increased $3.3 million as a result of general business and customer growth and continued build-out needed to support that growth, including investment in IT security.
FDIC insurance assessment expense for the nine months ended September 30, 2016 increased $5.4 million compared to the same period in 2015 as a result of the increase in total assets from September 30, 2015 to September 30, 2016.
Analysis of Financial Condition
Loans Held for Investment
Loans were as follows as of the dates indicated (in thousands):
 
September 30,
2016
 
December 31,
2015
Commercial
$
7,053,979

 
$
6,672,631

Mortgage finance
4,961,159

 
4,966,276

Construction
2,150,453

 
1,851,717

Real estate
3,391,831

 
3,139,197

Consumer
27,554

 
25,323

Leases
96,878

 
113,996

Gross loans held for investment
17,681,854

 
16,769,140

Deferred income (net of direct origination costs)
(58,301
)
 
(57,190
)
Allowance for loan losses
(180,436
)
 
(141,111
)
Total loans held for investment, net
$
17,443,117

 
$
16,570,839

Total loans held for investment net of allowance for loan losses at September 30, 2016 increased $872.3 million from December 31, 2015 to $17.4 billion. Our business plan focuses primarily on lending to middle market businesses and successful professionals and entrepreneurs, and as such, commercial, real estate and construction loans have comprised a majority of our loan portfolio. Consumer loans generally have represented 1% or less of the portfolio. Mortgage finance loans relate to our mortgage warehouse lending operations in which we 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, 2016, we had $2.1 billion in syndicated loans, $548.4 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, 2016, $82.7 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 borrowers and the value of collateral securing our loans held for investment are located outside of Texas. However, as of September 30, 2016, 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 adequacy of the allowance for loan losses.
Summary of Loan Loss Experience
The provision for credit losses 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 of $22.0 million during the third quarter of 2016 compared to $13.8 million in the third quarter of 2015 and $16.0 million in the second quarter of 2016. The increase in provision recorded during the third quarter of 2016 compared to the same period in 2015 is related to the deterioration in our energy portfolio, growth in loans held for investment, excluding mortgage finance loans, and an increase in total criticized loans, as well as changes in applied risk weights. Risk weights are based on historical loss experience as well as changes in the composition of our pass-rated loan portfolio.
The allowance for credit losses, which includes a liability for losses on unfunded commitments, totaled $191.3 million at September 30, 2016, $150.1 million at December 31, 2015 and $138.1 million at September 30, 2015. The combined allowance percentage increased to 1.51% at September 30, 2016 from 1.28% and 1.19% at December 31, 2015 and September 30, 2015, respectively. The combined allowance as a percent of loans held for investment, excluding mortgage finance loans, has trended up during 2015 and into 2016 primarily as a result of the increasing provision for credit losses driven by deterioration in our energy portfolio and management's allocation of a higher reserve to the Bank's pass-rated portfolio as deemed appropriate in light of current environmental conditions.
The overall allowance for loan losses results from consistent application of our loan loss reserve methodology. At September 30, 2016, we believe the allowance is appropriate 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

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adequacy 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.
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, 2016
 
Year ended
December 31,
2015
 
Nine months ended 
 September 30, 2015
Allowance for loan losses:
 
 
 
 
 
Beginning balance
$
141,111

 
$
100,954

 
$
100,954

Loans charged-off:
 
 
 
 
 
Commercial
34,232

 
16,254

 
11,278

Real estate
528

 
389

 
346

Consumer
40

 
62

 
62

Leases

 
25

 
25

Total charge-offs
34,800

 
16,730

 
11,711

Recoveries:
 
 
 
 
 
Commercial
7,829

 
4,944

 
2,098

Construction
34

 
400

 
28

Real estate
36

 
33

 
397

Consumer
16

 
173

 
19

Leases
71

 
38

 
27

Total recoveries
7,986

 
5,588

 
2,569

Net charge-offs
26,814

 
11,142

 
9,142

Provision for loan losses
66,139

 
51,299

 
38,728

Ending balance
$
180,436

 
$
141,111

 
$
130,540

Allowance for off-balance sheet credit losses:
 
 
 
 
 
Beginning balance
$
9,011

 
$
7,060

 
$
7,060

Provision for off-balance sheet credit losses
1,861

 
1,951

 
522

Ending balance
$
10,872

 
$
9,011

 
$
7,582

Total allowance for credit losses
$
191,308

 
$
150,122

 
$
138,122

Total provision for credit losses
$
68,000

 
$
53,250

 
$
39,250

Allowance for loan losses to LHI
1.02
%
 
0.84
%
 
0.82
%
Allowance for loan losses to LHI excluding mortgage finance loans
1.42
%
 
1.20
%
 
1.13
%
Net charge-offs to average LHI(1)
0.22
%
 
0.07
%
 
0.08
%
Net charge-offs to average LHI excluding mortgage finance loans(1)
0.29
%
 
0.10
%
 
0.11
%
Total provision for credit losses to average LHI
0.55
%
 
0.35
%
 
0.35
%
Total provision for credit losses to average LHI excluding mortgage finance loans
0.74
%
 
0.48
%
 
0.49
%
Recoveries to total charge-offs
22.95
%
 
33.40
%
 
21.94
%
Allowance for off-balance sheet credit losses to off-balance sheet credit commitments
0.19
%
 
0.16
%
 
0.14
%
Combined allowance for credit losses to LHI
1.09
%
 
0.90
%
 
0.87
%
Combined allowance for credit losses to LHI excluding mortgage finance loans
1.51
%
 
1.28
%
 
1.19
%
Non-performing assets:
 
 
 
 
 
Non-accrual loans(4)
$
169,113

 
$
179,788

 
$
109,674

OREO(3)
19,009

 
278

 
187

Other repossessed assets

 
230

 

Total
$
188,122

 
$
180,296

 
$
109,861

Restructured loans
$

 
$
249

 
$
249

Loans past due 90 days and still accruing(2)
9,706

 
7,013

 
7,558

Allowance for loan losses to non-accrual loans
1.1x

 
0.8x

 
1.2x

 

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(1)
Interim period ratios are annualized.
(2)
At September 30, 2016December 31, 2015 and September 30, 2015, loans past due 90 days and still accruing include premium finance loans of $7.7 million, $6.6 million and $6.2 million, respectively. These loans are generally secured by obligations of insurance carriers to refund premiums on cancelled insurance policies. The refund of premiums from the insurance carriers can take 180 days or longer from the cancellation date.
(3)
We did not have a valuation allowance recorded against the OREO balance at September 30, 2016, December 31, 2015 or September 30, 2015.
(4)
As of September 30, 2016December 31, 2015 and September 30, 2015, non-accrual loans included $19.7 million, $24.9 million and $26.1 million, respectively, in loans that met the criteria for restructured.
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,
2016
 
December 31,
2015
 
September 30,
2015
 
 
 
 
 
 
Non-accrual loans(1)
 
 
 
 
 
Commercial
 
 
 
 
 
     Oil and gas properties
$
143,372

 
$
104,179

 
$
32,476

     Assets of the borrowers
17,335

 
30,360

 
43,870

     Inventory
2,020

 
2,099

 
2,130

    Other
3,606

 
2,020

 
1,722

Total commercial
166,333

 
138,658

 
80,198

Construction
 
 
 
 
 
     Commercial buildings

 
16,667

 
16,749

     Unimproved land

 

 

     Other
159

 

 

Total construction
159

 
16,667

 
16,749

Real estate
 
 
 
 
 
     Commercial property
2,087

 
2,867

 
2,909

     Unimproved land and/or developed residential lots

 
3,576

 
3,591

     Farm land

 
12,486

 

     Other
334

 
383

 
528

Total real estate
2,421

 
19,312

 
7,028

Consumer
200

 

 

Leases

 
5,151

 
5,699

Total non-accrual loans
169,113

 
179,788

 
109,674

Repossessed assets:
 
 
 
 
 
OREO(2)
19,009

 
278

 
187

Other repossessed assets

 
230

 

Total non-performing assets
$
188,122

 
$
180,296

 
$
109,861


(1)
As of September 30, 2016December 31, 2015 and September 30, 2015, non-accrual loans included $19.7 million, $24.9 million and $26.1 million, respectively, in loans that met the criteria for restructured.
(2)
We did not have a valuation allowance recorded against the OREO balance at September 30, 2016, December 31, 2015 or September 30, 2015.
Total non-performing assets at September 30, 2016 increased $78.3 million from September 30, 2015 and $7.8 million from December 31, 2015. We experienced a significant increase in levels of non-performing assets during the nine months ended September 30, 2016 compared to the same period in 2015, primarily related to deterioration in our energy portfolio, which was expected as energy prices remain low. Energy non-performing assets totaled $150.0 million at September 30, 2016 compared to

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$36.9 million at September 30, 2015 and $120.4 million at December 31, 2015. Our provision for credit losses increased as a result of changes in the applied risk weights, an increase in total criticized loans, primarily related to the energy portfolio, and continuing growth in loans held for investment, excluding mortgage finance loans. Risk weights are based on historical loss experience as adjusted for current environmental factors as well as changes in the composition of our pass-rated loan portfolio. This resulted in an increase in the allowance for loan losses as a percent of loans excluding mortgage finance loans for September 30, 2016 compared to December 31, 2015 and September 30, 2015.
Generally, we place loans held for investment 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, 2016, 816,000 of our non-accrual loans were earning on a cash basis. A loan is placed back on accrual status when both principal and interest are current and it is probable that we will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.
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, 2016, we had $26.3 million in loans of this type, compared to none at December 31, 2015, which were not included in either non-accrual or 90 days past due categories.
The table below summarizes the assets held in OREO at September 30, 2016 (in thousands):
Medical building
$
17,398

Oil and gas property
$
1,141

Other
$
470

Total OREO
$
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. So long as the property is retained, further reductions in appraised value will result in valuation adjustments being taken as non-interest expense. If the decline in value is believed to be permanent and not just driven by short-term market conditions, a direct write-down of the OREO balance may be taken. We generally pursue sales of OREO when conditions warrant, but we may choose to hold certain properties for a longer term, which can result in additional exposure to decreases in the appraised value of the asset and the incurrence of carrying costs during that holding period. We did not record a valuation expense during the nine months ended September 30, 2016 and 2015.
Loans Held for Sale
Through our MCA program, we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to GSEs such as Fannie Mae, Freddie Mac or Ginnie Mae. We have elected to carry these loans at fair value based on sales commitments and market quotes. Changes in the fair value of the loans held for sale are included in other non-interest income.
Residential mortgage loans 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 managed 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, 2016 and December 31, 2015 (in thousands):
 
September 30, 2016
 
December 31, 2015
Unpaid principal balance
620,207

 
82,853

Fair value
648,684

 
86,075

Fair value over/(under) unpaid principal balance
28,477

 
3,222

No loans held for sale were 90 days or more past due or on non-accrual as of September 30, 2016 and December 31, 2015.
The differences between the fair value carrying amount and the aggregate unpaid principal balance include changes in fair value recorded at and subsequent to funding, gains and losses on the related loan commitment prior to funding and premiums or discounts on acquired loans.

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We generally retain the right to service the loans sold, creating MSR assets on our balance sheet. A summary of MSR activities for the nine months ended September 30, 2016 is as follows (in thousands):
Servicing asset:(1)
 
    Balance, beginning of year
$
423

    Capitalized servicing rights
16,344

    Amortization
(891
)
Balance, end of period
15,876

Valuation allowance:
 
    Balance, beginning of year
$

    Increase in valuation allowance
$
414

Balance, end of period
$
414

Servicing asset, net(1)
$
15,462

Fair value
$
15,970

(1)
Mortgage servicing rights are reported on the consolidated balance sheets at lower of cost or market. Carrying value and fair value were the same at December 31, 2015, respectively.
At September 30, 2016 and December 31, 2015, our servicing portfolio of residential mortgage loans sold included 4,954 and 168 loans, respectively, with an outstanding principal balance of $1.3 billion and $39.0 million, respectively. In connection with the servicing of these loans, we maintain 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 $18.5 million at September 30, 2016.
As of September 30, 2016 and December 31, 2015, management used the following assumptions to determine the fair value of MSRs:
 
September 30, 2016
December 31, 2015
Average discount rates
10.09
%
9.76
%
Expected prepayment speeds
11.18
%
9.66
%
Weighted average life, in years
6.5

7.3

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 (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. During the nine months ended September 30, 2016, we originated or purchased and sold approximately $1.4 billion of mortgage loans.
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 probable losses inherent in the population of all loans sold based on trends in claims and actual loss severities experienced. The reserve will include 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 2015, we have no 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, 2016. The historical industry data loss factors and experienced losses will be accumulated for each sale vintage (year loan was sold) and applied to more recent sale vintages to estimate inherent losses not yet realized. Our estimated exposure related to these loans was $621,000 at September 30, 2016 and is recorded in other liabilities in the consolidated balance sheet. We had no losses due to repurchase, indemnification or make-whole obligations during the year ended September 30, 2016 as it relates to our MCA program.

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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, 2015 and for the nine months ended September 30, 2016 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.
Deposit growth and increases in borrowing capacity related to our mortgage finance loans have resulted in an increase in liquidity assets to $3.5 billion at September 30, 2016. The following table summarizes the growth in and composition of liquidity assets (in thousands):
 
September 30,
2016
 
December 31,
2015
 
September 30,
2015
Federal funds sold and securities purchased under resale agreements
$
30,000

 
$
55,000

 
$
25,000

Interest-bearing deposits
3,441,074

 
1,626,374

 
2,320,192

Total liquidity assets
$
3,471,074

 
$
1,681,374

 
$
2,345,192

 
 
 
 
 
 
Total liquidity assets as a percent of:
 
 
 
 
 
Total loans held for investment, excluding mortgage finance loans
27.8
%
 
14.3
%
 
20.3
%
Total loans held for investment
19.5
%
 
10.1
%
 
14.8
%
Total earning assets
17.0
%
 
9.2
%
 
12.9
%
Total deposits
20.8
%
 
11.1
%
 
15.5
%
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,
2016
 
December 31,
2015
 
September 30,
2015
Deposits from core customers
$
16,383.1

 
$
13,743.8

 
$
13,554.2

Deposits from core customers as a percent of total deposits
90.3
%
 
91.1
%
 
89.4
%
Relationship brokered deposits
$
1,762.0

 
$
1,340.8

 
$
1,611.1

Relationship brokered deposits as a percent of total deposits
9.7
%
 
8.9
%
 
10.6
%
Traditional brokered deposits
$

 
$

 
$

Traditional brokered deposits as a percent of total deposits
%
 
%
 
%
Average deposits from core customers(1)
$
15,058.0

 
$
13,172.6

 
$
12,764.9

Average deposits from core customers as a percent of total quarterly average deposits(1)
89.9
%
 
89.4
%
 
88.7
%
Average relationship brokered deposits(1)
$
1,699.7

 
$
1,566.8

 
$
1,630.0

Average relationship brokered deposits as a percent of total quarterly average deposits(1)
10.1
%
 
10.6
%
 
11.3
%
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, 2015.
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, 2016 increased by $3.1 billion from December 31, 2015 and increased $3.0 billion from September 30, 2015.
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, 2016 (in thousands): 
 
 
Federal funds purchased
$
73,768

Repurchase agreements
7,652

FHLB borrowings
1,650,000

Line of credit
20,000

Total short-term borrowings
$
1,751,420

Maximum short-term borrowings outstanding at any month-end during 2016
$
2,117,280

The following table summarizes our other borrowing capacities in excess of balances outstanding at September 30, 2016 (in thousands): 
 
 
FHLB borrowing capacity relating to loans
$
3,645,669

FHLB borrowing capacity relating to securities
1,867

Total FHLB borrowing capacity
$
3,647,536

Unused Federal funds lines available from commercial banks
$
1,161,000


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The following table summarizes our long-term borrowings as of September 30, 2016 (in thousands):
 
 
Subordinated notes
$
280,954

Trust preferred subordinated debentures
113,406

Total long-term borrowings
$
394,360

At September 30, 2016, we had a revolving, non-amortizing line of credit with a maximum availability of $130.0 million. This line of credit matures on December 21, 2016. 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, 2016, $20.0 million in borrowings were outstanding compared to none at December 31, 2015.
Our equity capital, including $150 million in preferred stock, averaged $1.7 billion for the nine months ended September 30, 2016, as compared to $1.5 billion for the same period in 2015. 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, 2016, 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, 2016, 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
$
17,657,225

 
$

 
$

 
$

 
$
17,657,225

Time deposits
462,635

 
18,628

 
6,635

 

 
487,898

Federal funds purchased and customer repurchase agreements
81,420

 

 

 

 
81,420

FHLB borrowings
1,650,000

 

 

 

 
1,650,000

Line of credit
20,000

 

 

 

 
20,000

Operating lease obligations(1)
15,665

 
15,723

 
43,061

 
30,681

 
105,130

Subordinated notes

 

 

 
280,954

 
280,954

Trust preferred subordinated debentures

 

 

 
113,406

 
113,406

Total contractual obligations
$
19,886,945

 
$
34,351

 
$
49,696

 
$
425,041

 
$
20,396,033

 
(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 GAAP and generally accepted practice within the banking industry. 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. Not all significant accounting policies require management to make difficult, subjective or complex judgments. However, the policies 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 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” 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 during 2014 and 2015, and prices have continued to be suppressed through 2016. 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 +/- 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 our board of directors 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, 2016, 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, 2016
(In thousands)
 
 
0-3 mo
Balance
 
4-12 mo
Balance
 
1-3 yr
Balance
 
3+ yr
Balance
 
Total
Balance
Assets:
 
 
 
 
 
 
 
 
 
Securities(1)
$
8,733

 
$
4,529

 
2,532

 
$
10,562

 
$
26,356

Total variable loans
16,138,644

 
28,543

 
22,057

 

 
16,189,244

Total fixed loans
398,986

 
1,146,312

 
433,124

 
162,872

 
2,141,294

Total loans(2)
16,537,630

 
1,174,855

 
455,181

 
162,872

 
18,330,538

Total interest sensitive assets
$
16,546,363

 
$
1,179,384

 
$
457,713

 
$
173,434

 
$
18,356,894

Liabilities:
 
 
 
 
 
 
 
 
 
Interest-bearing customer deposits
$
8,867,485

 
$

 
$

 
$

 
$
8,867,485

CDs & IRAs
204,939

 
257,696

 
18,628

 
6,635

 
487,898

Traditional brokered deposits

 

 

 

 

Total interest-bearing deposits
9,072,424

 
257,696

 
18,628

 
6,635

 
9,355,383

Repurchase agreements, Federal funds
     purchased, FHLB borrowings, line
     of credit
1,751,420

 

 

 

 
1,751,420

Subordinated notes

 

 

 
280,954

 
280,954

Trust preferred subordinated debentures

 

 

 
113,406

 
113,406

Total borrowings
1,751,420

 

 

 
394,360

 
2,145,780

Total interest sensitive liabilities
$
10,823,844

 
$
257,696

 
$
18,628

 
$
400,995

 
$
11,501,163

Gap
$
5,722,519

 
$
921,688

 
$
439,085

 
$
(227,561
)
 
$

Cumulative Gap
5,722,519

 
6,644,207

 
7,083,292

 
6,855,731

 
6,855,731

 
 
 
 
 
 
 
 
 
 
Demand deposits
 
 
 
 
 
 
 
 
$
8,789,740

Stockholders’ equity
 
 
 
 
 
 
 
 
1,725,782

Total
 
 
 
 
 
 
 
 
$
10,515,522

 
(1)
Securities based on fair market value.
(2)
Loans are stated at gross.
The table above sets forth the balances as of September 30, 2016 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.
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 2015 and the first nine months of 2016, we do not believe that analysis of an assumed decrease in

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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, 2016
 
September 30, 2015
Change in net interest income
$
117,094

 
$
241,366

 
$
86,998

 
$
182,672

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 Exchange Act of 1934, as amended) 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 Company’s 2015 Form 10-K for the fiscal year ended December 31, 2015.



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Table of Contents

ITEM 6.
EXHIBITS
 
(a)
Exhibits
 
10.1*
Form of Performance Award Agreement for Executive Officers, filed herewith.
 
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, 2016, 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
* Denotes management contract or compensatory plan.

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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 20, 2016
/s/ Peter B. Bartholow
Peter B. Bartholow
Chief Financial Officer
(Duly authorized officer and principal financial officer)



48

Table of Contents

EXHIBIT INDEX
 
 
 
Exhibit Number
 
10.1*
Form of Performance Award Agreement for Executive Officers, filed herewith.
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, 2016, 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
* Denotes management contract or compensatory plan.



49