10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended September 30, 2013

 

¨ 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 x  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 x        ¨ 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 x     Accelerated Filer ¨     Non-Accelerated Filer ¨     Small Reporting Company¨

(Do not check if a 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 x

APPLICABLE ONLY TO CORPORATE ISSUERS:

On November 7, 2013, 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                     40,982,263


Table of Contents

Texas Capital Bancshares, Inc.

Form 10-Q

Quarter Ended September 30, 2013

Index

 

Part I. Financial Information

  

Item 1.

  

Financial Statements

  
  

Consolidated Statements of Income and Other Comprehensive Income - Unaudited

     3   
  

Consolidated Balance Sheets - Unaudited

     4   
  

Consolidated Statements of Stockholders’ Equity - Unaudited

     5   
  

Consolidated Statements of Cash Flows - Unaudited

     6   
  

Notes to Consolidated Financial Statements - Unaudited

     7   
  

Financial Summaries - Unaudited

     32   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     34   

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     47   

Item 4.

  

Controls and Procedures

     50   

Part II. Other Information

  

Item 1A.

  

Risk Factors

     50   

Item 6.

  

Exhibits

     52   

Signatures

     53   

 

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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,  
    2013     2012     2013     2012  
 

 

 

 

Interest income

       

Loans

    $ 114,453      $ 100,830      $ 324,053      $ 286,895   

Securities

    682        1,125        2,394        3,635   

Federal funds sold

    22        2        41        7   

Deposits in other banks

    60        54        172        151   
 

 

 

 

Total interest income

    115,217        102,011        326,660        290,688   

Interest expense

       

Deposits

    3,699        3,378        10,172        10,332   

Federal funds purchased

    152        268        570        789   

Repurchase agreements

    4        3        13        10   

Other borrowings

    119        607        475        1,534   

Subordinated notes

    1,829        208        5,487        208   

Trust preferred subordinated debentures

    638        692        1,905        2,091   
 

 

 

 

Total interest expense

    6,441        5,156        18,622        14,964   
 

 

 

 

Net interest income

    108,776        96,855        308,038        275,724   

Provision for credit losses

    5,000        3,000        14,000        7,000   
 

 

 

 

Net interest income after provision for credit losses

    103,776        93,855        294,038        268,724   

Non-interest income

       

Service charges on deposit accounts

    1,659        1,684        5,109        4,912   

Trust fee income

    1,263        1,216        3,773        3,562   

Bank owned life insurance (BOLI) income

    423        549        1,384        1,658   

Brokered loan fees

    4,078        4,839        13,600        12,618   

Swap fees

    983        1,397        3,616        2,815   

Other

    2,025        867        5,358        4,639   
 

 

 

 

Total non-interest income

    10,431        10,552        32,840        30,204   

Non-interest expense

       

Salaries and employee benefits

    36,012        31,009        114,744        90,258   

Net occupancy expense

    4,342        3,653        12,334        10,936   

Marketing

    3,974        3,472        12,020        9,469   

Legal and professional

    3,937        4,916        12,584        12,237   

Communications and technology

    3,696        2,885        10,165        8,088   

Allowance and other carrying costs for OREO

    267        552        1,179        7,706   

FDIC insurance assessment

    4,357        1,332        6,134        4,497   

Other

    5,424        5,702        17,283        16,579   
 

 

 

 

Total non-interest expense

    62,009        53,521        186,443        159,770   
 

 

 

 

Income from continuing operations before income taxes

    52,198        50,886        140,435        139,158   

Income tax expense

    18,724        18,316        49,745        49,884   
 

 

 

 

Income from continuing operations

    33,474        32,570        90,690        89,274   

Income (loss) from discontinued operations (after-tax)

    2        (34)        2        (31)   
 

 

 

 

Net income

    33,476        32,536        90,692        89,243   

Preferred stock dividends

    2,437        -        4,956        -   
 

 

 

 

Net income available to common shareholders

    $         31,039      $         32,536      $         85,736      $         89,243   
 

 

 

 

Other comprehensive income

       

Change in net unrealized gain on available-for-sale securities arising during period, before tax

    $ (531)      $ (386)      $ (2,283)      $ (1,298)   

Income tax benefit related to net unrealized gain on available-for-sale securities

    (186)        (135)        (799)        (454)   
 

 

 

 

Other comprehensive loss, net of tax

    (345)        (251)        (1,484)        (844)   
 

 

 

 

Comprehensive income

    $ 33,131      $ 32,285      $ 89,208      $ 88,399   
 

 

 

 

Basic earnings per common share

       

Income from continuing operations

    $ 0.76      $ 0.82      $ 2.10      $ 2.32   

Net income

    $ 0.76      $ 0.82      $ 2.10      $ 2.32   

Diluted earnings per common share

       

Income from continuing operations

    $ 0.74      $ 0.80      $ 2.05      $ 2.25   

Net income

    $ 0.74      $ 0.80      $ 2.05      $ 2.25   

See accompanying notes to consolidated financial statements.

 

 

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TEXAS CAPITAL BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands except share data)

     September 30,      December 31,  
     2013      2012  
  

 

 

 
     (Unaudited)      

Assets

     

Cash and due from banks

     $ 118,268       $ 111,938   

Interest-bearing deposits

     76,690         94,410   

Federal funds sold and securities purchased under resale agreements

     100         -   

Securities, available-for-sale

     67,815         100,195   

Loans held for sale

     2,262,085         3,175,272   

Loans held for sale from discontinued operations

     296         302   

Loans held for investment (net of unearned income)

     8,051,328         6,785,535   

Less: Allowance for loan losses

     84,006         74,337   
  

 

 

 

Loans held for investment, net

     7,967,322         6,711,198   

Premises and equipment, net

     12,653         11,445   

Accrued interest receivable and other assets

     271,052         316,201   

Goodwill and intangible assets, net

     21,463         19,883   
  

 

 

 

Total assets

     $ 10,797,744       $ 10,540,844   
  

 

 

 

Liabilities and Stockholders’ Equity

     

Liabilities:

     

Deposits:

     

Non-interest bearing

     $ 3,242,060       $ 2,535,375   

Interest bearing

     5,344,152         4,576,120   

Interest bearing in foreign branches

     370,869         329,309   
  

 

 

 

Total deposits

     8,957,081         7,440,804   

Accrued interest payable

     743         650   

Other liabilities

     99,161         91,581   

Federal funds purchased

     169,794         273,179   

Repurchase agreements

     29,899         23,936   

Other borrowings

     250,031         1,650,046   

Subordinated notes

     111,000         111,000   

Trust preferred subordinated debentures

     113,406         113,406   
  

 

 

 

Total liabilities

     9,731,115         9,704,602   

Stockholders’ equity:

     

Preferred stock

     150,000         -   

Common stock, $.01 par value:

     

Authorized shares – 100,000,000

     

Issued shares – 40,935,040 and 40,727,996 at September 30, 2013 and December 31, 2012, respectively

     409         407   

Additional paid-in capital

     446,249         450,116   

Retained earnings

     468,191         382,455   

Treasury stock (shares at cost: 417 at September 30, 2013 and December 31, 2012)

     (8)         (8)   

Accumulated other comprehensive income, net of taxes

     1,788         3,272   
  

 

 

 

Total stockholders’ equity

     1,066,629         836,242   
  

 

 

 

Total liabilities and stockholders’ equity

     $         10,797,744       $         10,540,844   
  

 

 

 

See accompanying notes to consolidated financial statements.

 

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TEXAS CAPITAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands except share data)

     Preferred Stock      Common Stock                    Treasury Stock      Accumulated         
  

 

 

          

 

 

       
     Shares      Amount      Shares      Amount      Additional
Paid-in
Capital
     Retained
Earnings
     Shares      Amount      Other
Comprehensive
Income, Net of
Taxes
     Total  
  

 

 

 

Balance at December 31, 2011

     -       $ -         37,666,708       $ 376       $ 349,458       $ 261,783         (417)       $ (8)       $ 4,722       $ 616,331   

Comprehensive income:

                             

Net income (unaudited)

     -         -         -         -         -         89,243         -         -         -         89,243   

Change in unrealized gain on available-for-sale securities, net of taxes of $454 (unaudited)

     -         -         -         -         -         -         -         -         (844)         (844)   
                             

 

 

 

Total comprehensive income (unaudited)

                                88,399   

Tax benefit related to exercise of stock-based awards (unaudited)

     -         -         -         -         5,773         -         -         -         -         5,773   

Stock-based compensation expense recognized in earnings (unaudited)

     -         -         -         -         4,648         -         -         -         -         4,648   

Issuance of stock related to stock-based awards (unaudited)

     -         -         613,992         7         261         -         -         -         -         268   

Issuance of stock (unaudited)

     -         -         2,300,000         23         86,964         -         -         -         -         86,987   
  

 

 

 

Balance at September 30, 2012 (unaudited)

     -       $ -         40,580,700       $ 406       $ 447,104       $ 351,026         (417)       $ (8)       $ 3,878       $ 802,406   
  

 

 

 

Balance at December 31, 2012

     -       $ -         40,727,996       $ 407       $ 450,116       $ 382,455         (417)       $ (8)       $ 3,272       $ 836,242   

Comprehensive income:

                             

Net income (unaudited)

     -         -         -         -         -         90,692         -         -         -         90,692   

Change in unrealized gain on available-for-sale securities, net of taxes of $799 (unaudited)

     -         -         -         -         -         -         -         -         (1,484)         (1,484)   
                             

 

 

 

Total comprehensive income (unaudited)

                                89,208   

Tax expense related to exercise of stock-based awards (unaudited)

     -         -         -         -         124         -         -         -         -         124   

Stock-based compensation expense recognized in earnings (unaudited)

     -         -         -         -         2,896         -         -         -         -         2,896   

Issuance of preferred stock (unaudited)

     6,000,000         150,000         -         -         (5,013)         -         -         -         -         144,987   

Preferred stock dividend (unaudited)

     -         -         -         -         -         (4,956)         -         -         -         (4,956)   

Issuance of stock related to stock-based awards (unaudited)

     -         -         207,044         2         (1,874)         -         -         -         -         (1,872)   
  

 

 

 

Balance at September 30, 2013 (unaudited)

         6,000,000       $       150,000             40,935,040       $         409       $       446,249       $       468,191             (417)       $         (8)       $         1,788       $       1,066,629   
  

 

 

 

See accompanying notes to consolidated financial statements

 

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TEXAS CAPITAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

(In thousands)

 

         Nine months ended September 30,      
             2013                     2012          
  

 

 

 

Operating activities

    

Net income from continuing operations

     $ 90,690      $ 89,274   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

    

Provision for credit losses

     14,000        7,000   

Depreciation and amortization

     8,224        3,569   

Amortization and accretion on securities

     19        31   

Bank owned life insurance (BOLI) income

     (1,384)        (1,658)   

Stock-based compensation expense

     14,464        9,886   

Tax expense from stock-based award exercises

     124        5,773   

Excess tax benefits (expense) from stock-based compensation arrangements

     (355)        (16,493)   

Originations of loans held for sale

     (39,620,728)        (36,239,859)   

Proceeds from sales of loans held for sale

     40,533,915        35,501,320   

Gain on sale of assets

     (490)        (357)   

Changes in operating assets and liabilities:

    

Accrued interest receivable and other assets

     38,259        (41,625)   

Accrued interest payable and other liabilities

     (3,097)        2,814   
  

 

 

 

Net cash provided by (used in) operating activities of continuing operations

     1,073,641        (680,325)   

Net cash provided by operating activities of discontinued operations

     7        57   
  

 

 

 

Net cash provided by (used in) operating activities

     1,073,648        (680,268)   

Investing activities

    

Purchases of available-for-sale securities

     -        (6)   

Maturities and calls of available-for-sale securities

     15,090        14,260   

Principal payments received on available-for-sale securities

     14,988        20,839   

Net increase in loans held for investment

     (1,270,123)        (980,292)   

Purchase of premises and equipment, net

     (3,828)        (2,505)   

Proceeds from sale of foreclosed assets

     4,026        12,482   

Cash paid for acquisition

     (2,445)        -   
  

 

 

 

Net cash used in investing activities of continuing operations

     (1,242,292)        (935,222)   

Financing activities

    

Net increase in deposits

     1,516,277        1,161,322   

Proceeds from issuance of stock related to stock-based awards

     (1,872)        268   

Proceeds from issuance of common stock

     -        86,987   

Proceeds from issuance of preferred stock

     144,987        -   

Preferred dividends paid

     (4,956)        -   

Net increase (decrease) in other borrowings

     (1,394,052)        216,972   

Excess tax benefits from stock-based compensation arrangements

     355        16,493   

Net increase (decrease) in Federal funds purchased

     (103,385)        61,081   

Issuance of subordinated notes

     -        111,000   
  

 

 

 

Net cash provided by financing activities of continuing operations

     157,354        1,654,123   
  

 

 

 

Net increase (decrease) in cash and cash equivalents

     (11,290)        38,633   

Cash and cash equivalents at beginning of period

     206,348        110,558   
  

 

 

 

Cash and cash equivalents at end of period

     $ 195,058      $ 149,191   
  

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid during the period for interest

     $ 18,529      $ 14,524   

Cash paid during the period for income taxes

     55,246        56,552   

Non-cash transactions:

    

Transfers from loans/leases to OREO and other repossessed assets

     980        3,410   

See accompanying notes to consolidated financial statements.

 

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TEXAS CAPITAL BANCSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED

(1)   OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Nature of Business

Texas Capital Bancshares, Inc. (“the Company”), a Delaware financial holding company, was incorporated in November 1996 and commenced doing business in March 1998, but did not commence banking operations until 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”). The Bank currently provides commercial banking services to its customers largely in Texas and concentrates on middle market commercial businesses and successful professionals and entrepreneurs.

Basis of Presentation

The accounting and reporting policies of Texas Capital Bancshares, Inc. conform to accounting principles generally accepted in the United States and to generally accepted practices within the banking industry. Our consolidated financial statements include the accounts of Texas Capital Bancshares, Inc. and its subsidiary, the Bank. 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 accounting principles generally accepted in the United States 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 interim financial information not misleading. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with 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, 2012, included in our Annual Report on Form 10-K filed with the SEC on February 21, 2013 (the “2012 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 financial instruments and the status of contingencies are particularly susceptible to significant change in the near term.

Cash and Cash Equivalents

Cash equivalents include amounts due from banks, Federal funds sold and securities purchased under resale agreements.

Securities

Securities are classified as trading, available-for-sale or held-to-maturity. Management classifies securities at the time of purchase and re-assesses such designation at each balance sheet date; however, transfers between categories from this re-assessment are rare.

Trading Account

Securities acquired for resale in anticipation of short-term market movements are classified as trading, with realized and unrealized gains and losses recognized in income. To date, we have not had any activity in our trading account.

 

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Held-to-Maturity and Available-for-Sale

Debt securities are classified as held-to-maturity when we have the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity or trading and marketable equity securities not classified as trading are classified as available-for-sale.

Available-for-sale securities are stated at fair value, with the unrealized gains and losses reported in a separate component of accumulated other comprehensive income, net of tax. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization and accretion is included in interest income from securities. Realized gains and losses and declines in value judged to be other-than-temporary are included in gain (loss) on sale of securities. The cost of securities sold is based on the specific identification method.

All securities are available-for-sale as of September 30, 2013 and December 31, 2012.

Loans

Loans Held for Investment

Loans held for investment (which include equipment leases accounted for as financing leases) are stated at the amount of unpaid principal reduced by deferred income (net of costs). Interest on loans is recognized using the simple-interest method on the daily balances of the principal amounts outstanding. Loan origination fees, net of direct loan origination costs, and commitment fees, are deferred and amortized as an adjustment to yield over the life of the loan, or over the commitment period, as applicable.

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 loan agreement. Reserves on impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

The accrual of interest on loans is discontinued 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 book balance of the asset is deemed to be collectible. If collectability is questionable, then cash payments are applied to principal. 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.

Loans Held for Sale

We purchase legal ownership interests in mortgage loans for sale in the secondary market through our mortgage finance division. The ownership interests are purchased from unaffiliated mortgage originators who are seeking additional funding through sale of the undivided ownership interests to facilitate their ability to originate loans. The mortgage originator has no obligation to offer and we have no obligation to purchase these interests. The originator closes mortgage loans consistent with underwriting standards established by approved investors, and, at the time of the sale to the investor, our ownership interest is delivered by us to the investor selected by the originator and approved by us. We typically purchase up to a 99% ownership interest. These loans are held by us for an interim period, usually less than 30 days and more typically 10-20 days. Because of conditions in agreements with originators designed to reduce transaction risks, under the form-based rules of Accounting Standards Codification 860, Transfers and Servicing of Financial Assets (“ASC 860”), the ownership interests do not qualify as participating interests. Under ASC 860, the ownership interests are deemed to be loans to the originator, although we have an actual, legal ownership interest in the underlying residential mortgage loans to individual borrowers. Accordingly, because we intend to sell and do sell directly to third party investors our legal ownership interest in the mortgage loans, which give rise to the loan to the originator, the loans to the originators are classified as held for sale and are carried at the lower of cost or fair value, determined on an individual loan basis.

 

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Due to market conditions or events of default by the investor or the originator, we could be required to purchase the remaining interests in the underlying mortgage loans and transfer them to our loans held for investment portfolio at fair value. Mortgage loans transferred to our loans held for investment portfolio could require future allocations of the allowance for loan losses or be subject to charge off in the event the loans become impaired.

We sell participations in our ownership interests to other financial institutions. These qualify as participating interests under ASC 860 and such sales reduce our loans held for sale balance on the balance sheet.

Supplemental Call Report instructions issued in October 2013 resulted in Texas Capital Bank reporting mortgage loan interests as held for investment rather than held for sale in its September 30, 2013 Call Report. See Note 7 – Regulatory Matters for further discussion.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged against income. The allowance for loan losses includes specific reserves for impaired loans and a general reserve for estimated losses inherent in the loan portfolio at the balance sheet date, but not yet identified with specific loans. Loans deemed to be uncollectible are charged against the allowance when management believes that the collectibility of the principal is unlikely and subsequent recoveries, if any, are credited to the allowance. Management’s periodic evaluation of the adequacy of the allowance is based on an assessment of the current loan portfolio, including known inherent risks, adverse situations that may affect the borrowers’ ability to repay, the estimated value of any underlying collateral and current economic conditions.

Repossessed Assets

Repossessed assets, which are included in other assets on the balance sheet, consist of collateral that has been repossessed. Collateral that has been repossessed is recorded at fair value less selling costs through a charge to the allowance for loan losses, if necessary. Write-downs are provided for subsequent permanent declines in value and are recorded in other non-interest expense.

Other Real Estate Owned

Other real estate owned (“OREO”), which is included in other assets on the balance sheet, consists of real estate that has been foreclosed. Real estate that has been foreclosed is recorded at the fair value of the real estate, less selling costs, through a charge to the allowance for loan losses, if necessary. Subsequent write-downs required for declines in value are recorded through a valuation allowance, or taken directly to the asset, charged to other non-interest expense.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from three to ten years. Gains or losses on disposals of premises and equipment are included in results of operations.

Marketing and Software

Marketing costs are expensed as incurred. Ongoing maintenance and enhancements of websites are expensed as incurred. Costs incurred in connection with development or purchase of internal use software are capitalized and amortized over a period not to exceed five years. Capitalized internal use software costs are included in other assets in the consolidated financial statements.

Goodwill and Other Intangible Assets

Intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. Our intangible assets relate primarily to loan customer relationships. Intangible assets with definite useful lives are amortized on an accelerated basis over their estimated life. Intangible assets are tested for impairment annually or whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

 

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Segment Reporting

We have determined that all of our lending divisions and subsidiaries meet the aggregation criteria of ASC 280, Segment Reporting, since all offer similar products and services, operate with similar processes, and have similar customers.

Stock-based Compensation

We account for all stock-based compensation transactions in accordance with ASC 718, Compensation – Stock Compensation (“ASC 718”), which requires that stock compensation transactions be recognized as compensation expense in the statement of operations based on their fair values on the measurement date, which is the date of the grant.

Accumulated Other Comprehensive Income

Unrealized gains or losses on our available-for-sale securities (after applicable income tax expense or benefit) are included in accumulated other comprehensive income, net. Accumulated comprehensive income, net for the nine months ended September 30, 2013 and 2012 is reported in the accompanying consolidated statements of changes in stockholders’ equity and consolidated statements of income and comprehensive income.

Income Taxes

The Company and its subsidiary file a consolidated federal income tax return. We utilize the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based upon the difference between the values of the assets and liabilities as reflected in the financial statements and their related tax basis using enacted tax rates in effect for the year in which the differences are expected to be recovered or settled. As changes in tax law or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. A valuation reserve is provided against deferred tax assets unless it is more likely than not that such deferred tax assets will be realized.

Basic and Diluted Earnings Per Common Share

Basic earnings per common share is based on net income available to common stockholders divided by the weighted-average number of common shares outstanding during the period excluding non-vested stock. Diluted earnings per common share include the dilutive effect of stock options and non-vested stock awards granted using the treasury stock method. A reconciliation of the weighted-average shares used in calculating basic earnings per common share and the weighted average common shares used in calculating diluted earnings per common share for the reported periods is provided in Note 2 – Earnings Per Common Share.

Fair Values of Financial Instruments

ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value, establishes a framework for measuring fair value under GAAP and enhances disclosures about fair value measurements. In general, fair values of financial instruments are based upon quoted market prices, where available. If such quoted market prices are not available, fair value is 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.

 

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(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,

 
     2013     2012     2013     2012  
  

 

 

 

Numerator:

        

Net income from continuing operations

     $ 33,474      $ 32,570      $ 90,690      $ 89,274   

Preferred stock dividends

     2,437        -        4,956        -   
  

 

 

 

Net income from continuing operations available to common shareholders

     31,037        32,570        85,734        89,274   

Income (loss) from discontinued operations

     2        (34)        2        (31)   
  

 

 

 

Net income

     $ 31,039      $ 32,536      $ 85,736      $ 89,243   
  

 

 

 

Denominator:

        

Denominator for basic earnings per share - weighted average shares

         40,901,867            39,618,007            40,824,223            38,513,515   

Effect of employee stock-based awards(1)

     375,773        632,790        415,867        677,782   

Effect of warrants to purchase common stock

     514,034        504,936        502,294        459,898   
  

 

 

 

Denominator for dilutive earnings per share - adjusted weighted average shares and assumed conversions

     41,791,674        40,755,733        41,742,384        39,651,195   
  

 

 

 

Basic earnings per common share from continuing operations

     $ 0.76      $ 0.82      $ 2.10      $ 2.32   
  

 

 

 

Basic earnings per common share

     $ 0.76      $ 0.82      $ 2.10      $ 2.32   
  

 

 

 

Diluted earnings per share from continuing operations

     $ 0.74      $ 0.80      $ 2.05      $ 2.25   
  

 

 

 

Diluted earnings per common share

     $ 0.74      $ 0.80      $ 2.05      $ 2.25   
  

 

 

 

 

(1) Stock options, SARs and RSUs outstanding of 98,000 at September 30, 2013 and 47,000 at September 30, 2012 have not been included in diluted earnings per share because to do so would have been anti-dilutive for the periods presented.

(3)  SECURITIES

Securities are identified as either held-to-maturity or available-for-sale based upon various factors, including asset/liability management strategies, liquidity and profitability objectives, and regulatory requirements. Held-to-maturity securities are carried at cost, adjusted for amortization of premiums or accretion of discounts. Available-for-sale securities are securities that may be sold prior to maturity based upon asset/liability management decisions. Securities identified as available-for-sale are carried at fair value. Unrealized gains or losses on available-for-sale securities are recorded as accumulated other comprehensive income in stockholders’ equity, net of taxes. Amortization of premiums or accretion of discounts on mortgage-backed securities is periodically adjusted for estimated prepayments. Realized gains and losses and declines in value judged to be other-than-temporary are included in gain (loss) on sale of securities. The cost of securities sold is based on the specific identification method.

At September 30, 2013, our net unrealized gain on the available-for-sale securities portfolio was $2.8 million compared to $5.0 million at December 31, 2012. As indicated by the difference in the gain as a percent of the amortized cost, the reduction in the total unrealized gain was due almost entirely to the reduction in the balances of the securities held. As a percent of outstanding balances, the unrealized gain was 4.23% and 5.02%, respectively, for the periods presented.

 

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The following is a summary of securities (in thousands):

     September 30, 2013  
            Gross      Gross         Estimated      
         Amortized              Unrealized              Unrealized         Fair  
     Cost      Gains      Losses     Value  
  

 

 

 

Available-for-Sale Securities:

          

Residential mortgage-backed securities

     $ 42,343         $ 2,735         $ -        $ 45,078   

Municipals

     15,202         207         -        15,409   

Equity securities(1)

     7,519         -         (191     7,328   
  

 

 

 
     $ 65,064         $ 2,942         $ (191     $ 67,815   
  

 

 

 
     December 31, 2012  
            Gross      Gross     Estimated  
     Amortized      Unrealized      Unrealized     Fair  
     Cost      Gains      Losses     Value  
  

 

 

 

Available-for-Sale Securities:

          

Residential mortgage-backed securities

     $ 57,342         $ 4,239         $ -        $ 61,581   

Corporate securities

     5,000         80         -        5,080   

Municipals

     25,300         594         -        25,894   

Equity securities(1)

     7,519         121         -        7,640   
  

 

 

 
     $ 95,161         $ 5,034         $ -        $ 100,195   
  

 

 

 

 

(1) Equity securities consist of Community Reinvestment Act funds.

The amortized cost and estimated fair value of securities are presented below by contractual maturity (in thousands, except percentage data):

 

     September 30, 2013  
            After One      After Five                
         Less Than          Through      Through      After Ten         
         One Year          Five Years      Ten Years      Years      Total  
  

 

 

 

Available-for-sale:

              

Residential mortgage-backed securities:(1)

              

Amortized cost

     $ 445       $ 16,140       $ 8,712       $ 17,046       $ 42,343   

Estimated fair value

     473         17,126         9,464         18,015         45,078   

Weighted average yield(3)

     4.28%         4.78%         5.55%         2.55%         4.04%   

Municipals:(2)

              

Amortized cost

     8,550         6,652         -         -         15,202   

Estimated fair value

     8,679         6,730         -         -         15,409   

Weighted average yield(3)

     5.75%         5.70%         -         -         5.73%   

Equity securities:(4)

              

Amortized cost

     7,519         -         -         -         7,519   

Estimated fair value

     7,328         -         -         -         7,328   
              

 

 

 

Total available-for-sale securities:

              

Amortized cost

                 $       65,064   
              

 

 

 

Estimated fair value

                 $ 67,815   
              

 

 

 

 

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     December 31, 2012  
            After One      After Five                
         Less Than          Through      Through      After Ten         
         One Year          Five Years      Ten Years      Years      Total  
  

 

 

 

Available-for-sale:

              

Residential mortgage-backed securities:(1)

              

Amortized cost

     $ 656       $ 5,698       $ 23,111       $ 27,877       $ 57,342   

Estimated fair value

     690         6,113         24,948         29,830         61,581   

Weighted average yield(3)

     4.20%         5.29%         4.86%         3.41%         4.19%   

Corporate securities:

              

Amortized cost

     5,000         -         -         -         5,000   

Estimated fair value

     5,080         -         -         -         5,080   

Weighted average yield(3)

     7.38%         -         -         -         7.38%   

Municipals:(2)

              

Amortized cost

     6,575         16,448         2,277         -         25,300   

Estimated fair value

     6,646         16,895         2,353         -         25,894   

Weighted average yield(3)

     5.75%         5.66%         6.01%         -         5.72%   

Equity securities:(4)

              

Amortized cost

     7,519         -         -         -         7,519   

Estimated fair value

     7,640         -         -         -         7,640   

Total available-for-sale securities:

              
              

 

 

 

Amortized cost

                 $ 95,161   
              

 

 

 

Estimated fair value

                 $         100,195   
              

 

 

 

 

(1) Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
(2) Yields have been adjusted to a tax equivalent basis assuming a 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 $49.5 million were pledged to secure certain borrowings and deposits at September 30, 2013. Of the pledged securities at September 30, 2013, approximately $8.4 million were pledged for certain deposits, and approximately $41.1 million were pledged for repurchase agreements.

The following table discloses, as of September 30, 2013, 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):

 

     Less Than 12 Months      12 Months or Longer      Total  
         Fair Value              Unrealized    
Loss
         Fair Value              Unrealized    
Loss
         Fair Value              Unrealized    
Loss
 
  

 

 

    

 

 

    

 

 

 

Equity securities

     $ 7,328       $ (191)       $ -       $ -       $ 7,328       $ (191)   

At September 30, 2013, there was one investment position in an unrealized loss position. This security is a publicly traded equity fund and is subject to market pricing volatility. We do not believe these unrealized losses are “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. We have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities.

At December 31, 2012, we did not have any investment securities in an unrealized loss position.

 

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(4)  LOANS AND ALLOWANCE FOR LOAN LOSSES

At September 30, 2013 and December 31, 2012, loans were as follows (in thousands):

 

       September 30, 
  2013 
    December 31,
2012
 
  

 

 

 

Commercial

     $ 4,782,234  $        4,106,419   

Construction

     1,125,908            737,637   

Real estate

     2,087,058            1,892,451   

Consumer

     19,619            19,493   

Leases

     85,936            69,470   
  

 

 

 

Gross loans held for investment

     8,100,755            6,825,470   

Deferred income (net of direct origination costs)

     (49,427)            (39,935)   

Allowance for loan losses

     (84,006)            (74,337)   
  

 

 

 

Total loans held for investment, net

     7,967,322            6,711,198   

Loans held for sale

     2,262,085            3,175,272   
  

 

 

 

Total

     $       10,229,407  $        9,886,470   
  

 

 

 

Commercial Loans and Leases. Our commercial loan and lease 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. 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 making loans on a transactional 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 and are supported by accounts receivable, inventory, equipment and other assets of our clients’ businesses.

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 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 lack of transactions at comparable values.

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. Construction loans are generally based 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 extremely 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.

Loans Held for Sale. Our loans held for sale consist of ownership interests purchased in single-family residential mortgages funded through our mortgage finance group. These loans are held by us for an interim period, usually less than 30 days and more typically 10-20 days. We have agreements with mortgage lenders and purchase legal 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. Loans held for sale as of September 30, 2013 and December 31, 2012 are net of $133.9 million and $436.0 million, respectively, of participations sold.

 

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As of September 30, 2013, a substantial majority of the principal amount of the loans held for investment in our portfolio was to businesses and individuals in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for loan losses. Management believes the allowance for loan losses is appropriate to cover estimated losses on loans at each balance sheet date.

At September 30, 2013, certain real estate loans used as collateral for Federal Home Loan Bank (“FHLB”) borrowings were subject to a blanket floating lien.

The reserve for loan losses is comprised of specific reserves for impaired loans and an estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We regularly evaluate our reserve for loan losses to maintain an appropriate level to absorb estimated loan losses inherent in the loan portfolio. Factors contributing to the determination of reserves include the credit worthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All loan commitments rated substandard or worse and greater than $500,000 are specifically reviewed for loss potential. For loans deemed to be impaired, a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, the portfolio is segregated by product types to recognize differing risk profiles among categories, and then further segregated by credit grades. Credit grades are assigned to all loans. Each credit grade is assigned a risk factor, or reserve allocation percentage. These risk factors are multiplied by the outstanding principal balance and risk-weighted by product type to calculate the required reserve. A similar process is employed to calculate a reserve assigned to off-balance sheet commitments, specifically unfunded loan commitments and letters of credit, and any needed reserve is recorded in other liabilities. Even though portions of the allowance may be allocated to specific loans, the entire allowance is available for any credit that, in management’s judgment, should be charged off.

We have several pass credit grades that are assigned to loans based on varying levels of risk, ranging from credits that are secured by cash or marketable securities, to watch credits which have all the characteristics of an acceptable credit risk but warrant more than the normal level of monitoring. Within our criticized/classified credit grades are special mention, substandard, and doubtful. Special mention loans are those that are currently protected by sound worth and paying capacity of the borrower, but that are potentially weak and constitute an additional credit risk. The loan has the potential to deteriorate to a substandard grade due to the existence of financial or administrative deficiencies. Substandard loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Some substandard loans are inappropriately protected by sound worth and paying capacity of the borrower and of the collateral pledged and may be considered impaired. Substandard loans can be accruing or can be on non-accrual depending on the circumstances of the individual loans. Loans classified as doubtful have all the weaknesses inherent in substandard loans with the added characteristics that the weaknesses make collection or liquidation in full highly questionable and improbable. The possibility of loss is extremely high. All doubtful loans are on nonaccrual.

The reserve allocation percentages assigned to each credit grade have been developed based primarily on an analysis of our historical loss rates. The allocations are adjusted for certain qualitative factors for such things as general economic conditions, changes in credit policies and lending standards. Historical loss rates are adjusted to account for current environmental conditions which we believe are likely to cause loss rates to be higher or lower than past experience. Each quarter we produce an adjustment range for environmental factors unique to us and our market. Changes in the trend and severity of problem loans can cause the estimation of losses to differ from past experience. In addition, the reserve considers the results of reviews performed by independent third party reviewers as reflected in their confirmations of assigned credit grades within the portfolio. The portion of the allowance that is not derived by the allowance allocation percentages compensates 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 evaluate many factors and conditions in determining the unallocated portion of the allowance, including the economic and business conditions affecting key lending areas, credit quality trends and general growth in the portfolio. The allowance is considered appropriate, given management’s assessment of potential losses within the portfolio as of the evaluation date, the significant growth in the loan and lease portfolio, current economic conditions in the Company’s market areas and other factors.

The methodology used in the periodic review of reserve adequacy, which is performed at least quarterly, is designed to be dynamic and responsive to changes in portfolio credit quality. The changes are reflected in the general reserve and in specific reserves as the collectability of larger classified loans is evaluated with new information. As our portfolio has matured, historical loss ratios have been closely monitored, and our reserve adequacy relies primarily on our loss history. Currently, the review of reserve adequacy is performed by executive management and presented to our board of directors for their review, consideration and ratification on a quarterly basis.

 

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The following tables summarize the credit risk profile of our loan portfolio by internally assigned grades and non-accrual status as of September 30, 2013 and December 31, 2012 (in thousands):

 

September 30, 2013

           
    Commercial     Construction         Real Estate         Consumer       Leases       Total  
 

 

 

 

Grade:

           

Pass

    $     4,674,546  $        1,122,191  $        2,001,825  $        19,549  $        79,189  $        7,897,300   

Special mention

    34,144            2,909            39,170            -            1,914            78,137   

Substandard-accruing

    52,550            808            31,447            -            4,776            89,581   

Non-accrual

    20,994            -            14,616            70            57            35,737   
 

 

 

 

Total loans held for investment

    $     4,782,234  $        1,125,908  $        2,087,058  $        19,619  $        85,936  $        8,100,755   
 

 

 

 

December 31, 2012

           
        Commercial     Construction     Real Estate     Consumer     Leases     Total  
 

 

 

 

Grade:

           

Pass

    $     4,013,538  $        703,673  $        1,816,027  $        19,436  $        68,327  $        6,621,001   

Special mention

    33,137            11,957            12,461            -            919            58,474   

Substandard-accruing

    44,371            4,790            40,897            -            104            90,162   

Non-accrual

    15,373            17,217            23,066            57            120            55,833   
 

 

 

 

Total loans held for investment

    $     4,106,419  $        737,637  $        1,892,451  $        19,493  $        69,470  $        6,825,470   
 

 

 

 

 

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The following table details activity in the reserve for loan losses by portfolio segment for the nine months ended September 30, 2013 and September 30, 2012. Allocation of a portion of the reserve to one category of loans does not preclude its availability to absorb losses in other categories.

 

September 30, 2013

              
(in thousands)      Commercial             Construction             Real Estate             Consumer             Leases             Unallocated               Total      

Beginning balance

      $          21,547 $            12,097 $                30,893 $                226 $            2,460 $                7,114 $            74,337   

Provision for loan losses

     15,707           1,866           (4,793)           25           (4)           498           13,299   

Charge-offs

     4,970           -           144           45           2           -           5,161   

Recoveries

     978           -           210           64           279           -           1,531   
  

 

 

 

Net charge-offs (recoveries)

     3,992           -           (66)           (19)           (277)           -           3,630   
  

 

 

 

Ending balance

      $          33,262 $        13,963 $        26,166 $        270 $        2,733 $        7,612 $        84,006   
  

 

 

 

Period end amount allocated to:

              

Loans individually evaluated for impairment

      $            3,199 $        - $        1,064 $        11 $        9 $        - $        4,283   

Loans collectively evaluated for impairment

     30,063           13,963           25,102           259           2,724           7,612           79,723   
  

 

 

 

Ending balance

      $          33,262 $        13,963 $        26,166 $        270 $        2,733 $        7,612 $        84,006   
  

 

 

 

September 30, 2012

              
(in thousands)      Commercial             Construction             Real Estate             Consumer             Leases             Unallocated               Total      

Beginning balance

      $          17,337 $        7,845 $        33,721 $        223 $        2,356 $        8,813 $        70,295   

Provision for loan losses

     4,575           3,258           (2,840)           6           417           602           6,018   

Charge-offs

     2,664           -           899           49           170           -           3,782   

Recoveries

     482           10           586           26           87           -           1,191   
  

 

 

 

Net charge-offs (recoveries)

     2,182           (10)           313           23           83           -           2,591   
  

 

 

 

Ending balance

      $          19,730 $        11,113 $        30,568 $        206 $        2,690 $        9,415 $        73,722   
  

 

 

 

Period end amount allocated to:

              

Loans individually evaluated for impairment

      $            5,149 $        - $        775 $        18 $        42 $        - $        5,984   

Loans collectively evaluated for impairment

     14,581           11,113           29,793           188           2,648           9,415           67,738   
  

 

 

 

Ending balance

      $          19,730 $        11,113 $        30,568 $        206 $        2,690 $        9,415 $        73,722   
  

 

 

 

Our recorded investment in loans as of September 30, 2013, December 31, 2012 and September 30, 2012 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, 2013

                             
         Commercial            Construction            Real Estate            Consumer            Leases            Total    
    

 

 

 

Loans individually evaluated for impairment

       $ 23,422         $ -         $ 23,745         $ 70         $ 57         $ 47,294   

Loans collectively evaluated for impairment

       4,758,812           1,125,908           2,063,313           19,549           85,879           8,053,461   
    

 

 

 

Total

       $     4,782,234         $ 1,125,908         $ 2,087,058         $ 19,619         $ 85,936         $ 8,100,755   
    

 

 

 

December 31, 2012

                             
       Commercial        Construction        Real Estate        Consumer        Leases        Total  
    

 

 

 

Loans individually evaluated for impairment

       $ 15,373         $ 18,179         $ 32,512         $ 57         $ 120         $ 66,241   

Loans collectively evaluated for impairment

       4,091,046           719,458           1,859,939           19,436           69,350           6,759,229   
    

 

 

 

Total

       $     4,106,419         $ 737,637         $ 1,892,451         $ 19,493         $ 69,470         $ 6,825,470   
    

 

 

 

September 30, 2012

                             
         Commercial            Construction            Real Estate            Consumer            Leases              Total      
    

 

 

 

Loans individually evaluated for impairment

       $ 17,653         $ 19,248         $ 29,246         $ 60         $ 213         $ 66,420   

Loans collectively evaluated for impairment

       4,021,302           630,127           1,775,188           19,915           73,994           6,520,526   
    

 

 

 

Total

       $             4,038,955         $             649,375         $             1,804,434         $             19,975         $             74,207         $             6,586,946   
    

 

 

 

We have traditionally maintained an unallocated reserve component to allow for uncertainty in economic and other conditions affecting the quality of the loan portfolio. Fraud losses that do not correlate to historical loss rates for specific product types or credit risk grades are but one factor that continues to justify an unallocated reserve. Other factors include rapid loan growth, larger hold limits and anticipated changes in taxing and spending policies contributing to unprecedented economic and political uncertainty. 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.

 

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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. The table below summarizes our non-accrual loans by type and purpose as of September 30, 2013 (in thousands):

 

     September 30,
2013
  December 31,
2012
  

 

Commercial

    

Business loans

     $         20,994   $        15,373

Construction

    

Market risk

   -   17,217

Real estate

    

Market risk

   11,983   11,054

Commercial

   529   8,617

Secured by 1-4 family

   2,104   3,395

Consumer

   70   57

Leases

   57   120
  

 

Total non-accrual loans

     $         35,737   $        55,833
  

 

As of September 30, 2013, non-accrual loans included in the table above included $24.2 million related to loans that met the criteria for restructured compared to $19.6 million at December 31, 2012.

 

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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 loan agreement. In accordance with ASC 310 Receivables, 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, 2013 and December 31, 2012 (in thousands):

 

September 30, 2013

          
         Recorded
    Investment
    Unpaid
Principal
Balance
    Related
Allowance
    Average
Recorded
Investment
    Interest
Income
Recognized
 
  

 

 

 

With no related allowance recorded:

          

Commercial

          

Business loans

     $ 7,196      $ 7,196      $ -      $ 3,864      $ -   

Energy

     1,668        3,498        -        741        -   

Construction

          

Market risk

     -        -        -        4,069        114   

Real estate

          

Market risk

     11,211        11,211        -        9,068        -   

Commercial

     529        529        -        7,103        -   

Secured by 1-4 family

     2,512        2,512        -        2,580        -   

Consumer

     -        -        -        -        -   

Leases

     -        -        -        -        -   
  

 

 

 

Total impaired loans with no allowance recorded

     $         23,116      $         24,946      $ -      $         27,425      $             114   
  

 

 

 

With an allowance recorded:

          

Commercial

          

Business loans

     $ 14,558      $ 14,558      $ 3,199      $ 14,523      $ -   

Energy

     -        -        -        1,166        -   

Construction

          

Market risk

     -        -        -        214        -   

Real estate

          

Market risk

     8,728        8,728        823        7,911        -   

Commercial

     -        -        -        636        -   

Secured by 1-4 family

     765        765        241        784        -   

Consumer

     70        70        11        36        -   

Leases

     57        57        9        78        -   
  

 

 

 

Total impaired loans with an allowance recorded

     $           24,178      $           24,178      $           4,283      $           25,348      $ -   
  

 

 

 

Combined:

          

Commercial

          

Business loans

     $ 21,754      $ 21,754      $ 3,199      $ 18,387      $ -   

Energy

     1,668        3,498        -        1,907        -   

Construction

          

Market risk

     -        -        -        4,283        114   

Real estate

          

Market risk

     19,939        19,939        823        16,979        -   

Commercial

     529        529        -        7,739        -   

Secured by 1-4 family

     3,277        3,277        241        3,364        -   

Consumer

     70        70        11        36        -   

Leases

     57        57        9        78        -   
  

 

 

 

Total impaired loans

     $ 47,294      $ 49,124      $ 4,283      $ 52,773      $ 114   
  

 

 

 

 

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Table of Contents

December 31, 2012

          
         Recorded
    Investment
    Unpaid
Principal
Balance
    Related
Allowance
    Average
Recorded
Investment
    Interest
Income
Recognized
 
  

 

 

 

With no related allowance recorded:

          

Commercial

          

Business loans

     $ 2,938      $ 2,938      $ -      $ 1,409      $ -   

Construction

          

Market risk

     17,217        17,217        -        18,571        677   

Real estate

          

Market risk

     9,061        9,061        -        7,944        -   

Commercial

     6,604        6,604        -        6,451        -   

Secured by 1-4 family

     2,632        2,632        -        1,827        -   

Consumer

     -        -        -        -        -   

Leases

     -        -        -        -        -   
  

 

 

 

Total impaired loans with no allowance recorded

     $ 38,452      $ 38,452      $ -      $ 36,202      $ 677   
  

 

 

 

With an allowance recorded:

          

Commercial

          

Business loans

     $ 12,435      $ 18,391      $ 2,983      $ 15,484      $ -   

Construction

          

Market risk

     962        962        14        321        -   

Real estate

          

Market risk

     11,439        11,439        535        11,811        -   

Commercial

     2,013        2,013        89        671        -   

Secured by 1-4 family

     763        763        275        1,632        -   

Consumer

     57        57        16        59        -   

Leases

     120        120        18        182        -   
  

 

 

 

Total impaired loans with an allowance recorded

     $           27,789      $           33,745      $           3,930      $           30,160      $             -   
  

 

 

 

Combined:

          

Commercial

          

Business loans

     $ 15,373      $ 21,329      $ 2,983      $ 16,893      $ -   

Construction

          

Market risk

     18,179        18,179        14        18,892        677   

Real estate

          

Market risk

     20,500        20,500        535        19,755        -   

Commercial

     8,617        8,617        89        7,122        -   

Secured by 1-4 family

     3,395        3,395        275        3,459        -   

Consumer

     57        57        16        59        -   

Leases

     120        120        18        182        -   
  

 

 

 

Total impaired loans

     $ 66,241      $ 72,197      $ 3,930      $ 66,362      $ 677   
  

 

 

 

 

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Table of Contents

Average impaired loans outstanding during the nine months ended September 30, 2013 and 2012 totaled $52.8 million and $69.1 million, respectively.

The table below provides an age analysis of our past due loans that are still accruing as of September 30, 2013 (in thousands):

 

                 Greater                    
                 Than 90                    
    

    30-59

    Days

   

60-89

Days

    Days and     Total Past              
         Past Due     Past Due     Accruing(1)     Due     Current     Total  
  

 

 

 

Commercial

            

Business loans

    $ 36,703      $ 3,727      $ 7,084      $ 47,514      $ 3,737,690      $ 3,785,204   

Energy

     -        626        -        626        975,410        976,036   

Construction

            

Market risk

     278        705        -        983        1,112,011        1,112,994   

Secured by 1-4 family

     -        -        -        -        12,914        12,914   

Real estate

            

Market risk

     4,803        790        426        6,019        1,569,299        1,575,318   

Commercial

     2,970        -        -        2,970        400,002        402,972   

Secured by 1-4 family

     480        -        -        480        93,672        94,152   

Consumer

     482        -        -        482        19,067        19,549   

Leases

     4,998        -        -        4,998        80,881        85,879   
  

 

 

 

Total loans held for investment

    $         50,714      $           5,848      $           7,510      $         64,072      $     8,000,946      $     8,065,018   
  

 

 

 

 

(1) Loans past due 90 days and still accruing includes premium finance loans of $3.1 million. 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.

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 contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current rate for new debt with similar risk, or a reduction of the face amount of debt, or forgiveness of either principal or accrued interest. As of September 30, 2013 and December 31, 2012, we have $4.7 million and $10.4 million, respectively, in loans considered restructured that are not on non-accrual. As of September 30, 2013 these loans did not have an unfunded commitment total compared to $599,000 at December 31, 2012. Of the non-accrual loans at September 30, 2013 and December 31, 2012, $24.2 million and $19.6 million, respectively, met the criteria for restructured. These loans have no unfunded commitments at their respective balance sheet date. A loan continues to qualify as restructured until a consistent payment history or change in borrower’s financial condition has been evidenced, generally 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 modified terms in calendar years after the year of the restructure.

 

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Table of Contents

The following tables summarize, for the nine months ended September 30, 2013 and 2012, loans that have been restructured during 2013 and 2012, respectively, (in thousands):

 

September 30, 2013   Number of
Contracts
      Pre-Restructuring
Outstanding Recorded
Investment
      Post-Restructuring
Outstanding Recorded
Investment
 

 

Commercial business loans

  3   $   10,823   $   10,734

Real estate market risk

  1     892     892
 

 

Total new restructured loans in 2013

  4   $   11,715   $   11,626
 

 

September 30, 2012   Number of
Contracts
      Pre-Restructuring
Outstanding Recorded
Investment
      Post-Restructuring
Outstanding Recorded
Investment
 

 

Commercial business loans

  1   $   802   $   777

Real estate market risk

  2     1,726     1,162

Real estate - 1-4 family

  1     1,424     1,424
 

 

Total new restructured loans in 2012

  4   $   3,952   $   3,363
 

 

The restructured loans generally include terms to reduce the interest rate and extend payment terms. We have not forgiven 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, 2013.

The following table provides information on how loans were modified as a restructured loan during the nine months ended September 30, 2013 and 2012 (in thousands):

 

    September 30,  
    2013     2012  
 

 

 

 

Extended maturity

   $          892      $         1,939   

Adjusted payment schedule

    -        1,424   

Combination of maturity extension and payment schedule adjustment

    10,734        -   
 

 

 

 

Total

   $             11,626      $                 3,363   
 

 

 

 

As of September 30, 2013, 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,  
    2013     2012     2013     2012  
 

 

 

 

Beginning balance

      $     13,053      $     27,882      $     15,991      $     34,077   

Additions

    68        -        980        3,397   

Sales

    (316)        (8,739)        (3,712)        (12,467)   

Valuation allowance for OREO

    -        -        (164)        (3,556)   

Direct write-downs

    -        (64)        (290)        (2,372)   
 

 

 

 

Ending balance

      $     12,805      $     19,079      $     12,805      $     19,079   
 

 

 

 

 

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Table of Contents

(6)  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 which 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, 2013     December 31, 2012  
 

 

 

 

Commitments to extend credit

    $ 3,545,057      $ 2,648,454   

Standby letters of credit

    124,259        83,429   

(7)  REGULATORY MATTERS

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of September 30, 2013, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the tables below. As shown in the table below, the Company’s capital ratios exceed the regulatory definition of adequately capitalized as of September 30, 2013 and 2012. Based upon the information in its most recently filed call report, the Bank meets the capital ratios necessary to be well capitalized. The regulatory authorities can apply changes in classification of assets and such change may retroactively subject the Company to change in capital ratios. Any such change 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 effect on condition and results of operations.

 

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Table of Contents

In response to supplemental FFIEC Call Report instructions issued in early April 2013, we began using a 100% risk weight for the mortgage assets with our March 31, 2013 Call Report and Form 10-Q. In previous filings, we applied a 50% risk weight (or 20% risk weight for government-guaranteed loans) to these assets for purposes of calculating the Bank’s risk-based capital ratios. Having now determined that the 100% risk weight must be applied under our current program we were required to amend our year-end Call Reports for 2012 and 2011. This change required application of the 100% risk weight to our mortgage loan interests in these earlier periods, which is consistent with our March 2013 and June 2013 Call Reports. The amendment of Call Reports had no impact on our consolidation balance sheet or statements of operations, stockholders’ equity and cash flows.

This retroactive change in risk weighting of our mortgage loan interests required that we amend the previously reported values for our risk-weighted capital ratios for December 31, 2012 and 2011. See below for amended December 31, 2012 risk-weighted capital ratios. These amended ratios exceed levels required to be “adequately capitalized” on a consolidated basis and at the Bank. As amended, the Bank was “well capitalized” in the Tier 1 measure of capital adequacy, but the total risk-based capital ratio was below that required to be considered “well capitalized”. The adjustment had no impact on the ratio of tangible common equity to total assets. We believe that we had the financial and operational capacity to maintain well-capitalized status had we determined that the higher risk weighting was required to be applied to our ownership interests in mortgage loans at year-end 2012 and 2011.

Incidental to the amended Call Reports described above, we were assessed $3.0 million by the FDIC that was paid during the third quarter of 2013. We do not believe this is an assessment warranted under our circumstances, and we have disputed the charge. Any recovery of the $3.0 million expense would be credited to non-interest expense in a future quarter.

 

    September 30,
2013
    December 31,
2012
    September 30,
2012
 
 

 

 

 

Company

     

Risk-based capital:

     

Tier 1 capital

    9.67     8.27     10.35

Total capital

    11.34     9.97     12.55

Leverage

    10.85     9.41     9.63

Bank

     

Risk-based capital:

     

Tier 1 capital

    7.91     7.17     8.93

Total capital

    10.42     8.50     10.41

Leverage

    8.88     8.16     8.30

In July 2013, the Federal Reserve published final rules for the adoption of the Basel III regulatory capital framework (the “Basel III Capital Rules”). The Basel III Capital Rules, among other things, (i) introduce a new capital measure called “Common Equity Tier 1,” (ii) specify that Tier 1 capital consist of Common Equity Tier 1 and “Additional Tier 1 Capital” instruments meeting specified requirements, (iii) define Common Equity Tier 1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to Common Equity Tier 1 and not to the other components of capital and (iv) expand the scope of the deductions/adjustments as compared to existing regulations. The Basel III Capital Rules will be effective for us on January 1, 2015 with certain transition provisions fully phased in on January 1 2019. Based on our initial assessment of the Basel III Capital Rules, we do not believe they will have a material impact, and we believe we would meet the capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis if such requirements were currently in effect.

Federal Financial Institutions Examination Council Financial Institution Letter FIL-44-2013 issued October 7, 2013, included Supplemental Instructions for September 30, 2013 Call Reports (the “Supplemental Instructions”) requiring that reporting institutions consider whether loans originated by third parties and acquired by the institution should be accounted for as a purchase of loans held for sale or as a secured loan to the originator that is held for investment based upon factors identified in the Supplemental Instructions. For periods ending prior to September 30, 2013, we have reported interests in mortgage loans originated by our mortgage warehouse customers and acquired in our mortgage finance division as loans to the originator that are held for sale in our Call Reports and our financial statements.

 

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For Call Report purposes, we reported mortgage loan interests as held for investment commencing with the September 30, 2013 Call Report in accordance with the Supplemental Instructions. These financial assets continue to be classified as held for sale in our financial reporting.

The difference in reporting our mortgage loan interests for Call Report purposes does not impact our reported earnings as we do not believe any reserve for loan losses relating to the mortgage warehouse lending portfolio is necessary based upon the risk profile of the assets and the less than one basis point loss experience of the program over the past ten years.

The following table summarizes the differences between our financial reporting and Call Report resulting from the change described above (in thousands):

 

        Financial
Reporting
    Adjustment     Call Report  
   

 

 

 

September 30, 2013

       

Balance Sheet

       

Loans held for sale

  $     2,262,085        $    (2,262,085)      $ -   

Loans held for investment, net

      7,967,322        2,262,085        10,229,407   

Total loans, net

      10,229,407        -            10,229,407   

Had we classified our mortgage loan interests as held for investment for financial reporting or Call Report purposes as of December 31, 2012, total loans of $9.9 billion would have been unchanged.

Call Reports do not include a statement of cash flows. Had we classified our mortgage loan interests as held for investment for financial reporting purposes, the cash flows relating to these activities, which currently are reflected on a gross basis in operating cash flow activity, would be presented on a net basis in investing cash flow activity. The net origination and proceeds of loans held for sale of $913.2 million and $(738.5) million for the nine months ended September 30, 2013 and 2012, respectively, would have been presented in investing activities.

On August 1, 2012 we completed a sale of 2.3 million shares of our common stock in a public offering. Net proceeds from the sale totaled $87.0 million. The additional equity was used for general corporate purposes, including retirement of $15.0 million of debt and additional capital to support continued loan growth at our bank.

On September 21, 2012, we issued $111.0 million of subordinated notes. The notes mature in September 2042 and bear interest at a rate of 6.50% per annum, payable quarterly. The proceeds were used for general corporate purposes including funding regulatory capital infusions into the Bank. The indenture contains customary financial covenants and restrictions.

On March 28, 2013, we completed a sale of 6.0 million shares of 6.5% non-cumulative preferred stock in a public offering. Net proceeds from the sale totaled $145.0 million. The additional equity is being used for general corporate purposes, which may include funding regulatory capital infusions into the Bank.

(8)  STOCK-BASED COMPENSATION

The fair value of our stock 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 its employee stock options.

 

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Stock-based compensation consists of SARs and RSUs that were granted from 2007 through 2013.

 

    Three months ended
September 30,
    Nine months ended
September 30,
 
(in thousands)   2013     2012     2013     2012  
 

 

 

 

Stock- based compensation expense recognized:

       

SARs

    $ 130      $ 179        $ 412      $ 554   

RSUs

    923        916        2,484        4,094   
 

 

 

 

Total compensation expense recognized

    $         1,053      $         1,095        $         2,896      $         4,648   
 

 

 

 
                September 30, 2013  
(in thousands)               Options    

SARs and

RSUs

 
     

 

 

 

Unrecognized compensation expense related to unvested awards

        $ -      $ 12,521   

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

  

      -        3.73   

In connection with the 2010 Long-term Incentive Plan, the Company has issued cash-based performance units.

A summary of the compensation cost for these units is as follows (in thousands):

 

                                                                                                   
    Three months ended
September 30,
    Nine months ended
September 30,
 
    2013     2012     2013     2012  
 

 

 

 

Cash-based performance units

    $     2,161      $         2,337        $       11,568      $         5,238   

The compensation cost for the nine months ended September, 2013, includes approximately $4.1 million related to a charge taken to reflect the financial effect of the organizational changes announced during the second quarter of 2013 and includes assumptions about future payouts that may or may not happen. Additionally, there was another $2.2 million of charges related to the increased probability that certain performance targets for executive cash based incentives will be met, reflecting the increase in our stock price.

(9)  DISCONTINUED OPERATIONS

Subsequent to the end of the first quarter of 2007, we and the purchaser of our residential mortgage loan division (“RML”) agreed to terminate and settle the contractual arrangements related to the sale of the division, which had been completed as of the end of the third quarter of 2006. Historical operating results of RML are reflected as discontinued operations in the financial statements.

During the three months ended September 30, 2013 and 2012, the income and loss from discontinued operations was $2,000 and $34,000, net of taxes, respectively. During the nine months ended September 30, 2013 and 2012, the income from discontinued operations was $2,000 and $31,000, net of taxes, respectively. We still have approximately $296,000 in loans held for sale from discontinued operations that are carried at the estimated market value at quarter-end, which is less than the original cost. We plan to sell these loans, but timing and price to be realized cannot be determined at this time due to market conditions. In addition, we continue to address requests from investors related to repurchasing loans previously sold. While the balances as of September 30, 2013 include a liability for exposure to additional contingencies, including risk of having to repurchase loans previously sold, we recognize that market conditions may result in additional exposure to loss and the extension of time necessary to complete the discontinued mortgage operation.

(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 enhances 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.

 

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We determine the fair market values of our assets and liabilities measured at fair value on a recurring and nonrecurring basis using the fair value hierarchy as prescribed in ASC 820. The standard describes three levels of inputs that may be used to measure fair value as provided below.

 

  Level 1

Quoted prices in active markets for identical assets or liabilities. Level 1 assets include U.S. Treasuries that are highly liquid and are actively traded in over-the-counter markets.

 

  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, corporate securities, municipal bonds, and Community Reinvestment Act funds. This category includes 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 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, 2013 and December 31, 2012 are as follows (in thousands):

 

    Fair Value Measurements Using  
September 30, 2013   Level 1     Level 2     Level 3  
 

 

 

 

Available for sale securities:(1)

     

Residential mortgage-backed securities

    $                     -      $             45,078      $ -   

Municipals

    -        15,409        -   

Equity securities

    -        7,328        -   

Loans(2) (4)

    -        -        12,658   

OREO(3) (4)

    -        -                    12,805   

Derivative asset(5)

    -        13,886        -   

Derivative liability(5)

    -        (13,886)        -   

December 31, 2012

     

Available for sale securities:(1)

     

Residential mortgage-backed securities

    $ -      $ 61,581      $ -   

Corporate securities

    -        5,080        -   

Municipals

    -        25,894        -   

Equity securities

    -        7,640        -   

Loans(2) (4)

    -        -        11,639   

OREO(3) (4)

    -        -        15,991   

Derivative asset(5)

    -        28,473        -   

Derivative liability(5)

    -        (28,473)        -   

 

(1)

Securities are measured at fair value on a recurring basis, generally monthly.

(2)

Includes impaired loans that have been measured for impairment at the fair value of the loan’s collateral.

(3)

OREO is transferred from loans to OREO at fair value less selling costs.

(4)

Fair value of loans and OREO is measured on a nonrecurring basis, generally annually or more often as warranted by market and economic conditions

(5)

Derivative assets and liabilities are measured at fair value on a recurring basis, generally quarterly.

 

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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 fair value for certain loans on a nonrecurring basis as described below.

Loans

During the three and nine months ended September 30, 2013, certain impaired loans were reevaluated 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 $12.7 million total above includes impaired loans at September 30, 2013 with a carrying value of $12.7 million that did not have specific allowance allocations for a total reported fair value of $12.7 million based on collateral valuations utilizing Level 3 valuation inputs. Fair values were based on third party appraisals; however, based on the current economic conditions, comparative sales data typically used in the appraisals may be unavailable or more subjective due to the lack of real estate market activity.

OREO

Certain foreclosed assets, upon initial recognition, are valued based on third party appraisals less estimated selling costs. At September 30, 2013, OREO with a carrying value of $17.4 million was reduced by specific valuation allowance allocations totaling $4.6 million for a total reported fair value of $12.8 million based on valuations utilizing Level 3 valuation inputs. Fair values are based on third party appraisals; however, based on the current economic conditions, comparative sales data typically used in the appraisals may be unavailable or more subjective due to the lack of real estate market activity.

Fair Value of Financial Instruments

Generally accepted accounting principles 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, 2013     December 31, 2012  
        Carrying    
Amount
    Estimated
Fair Value
    Carrying
Amount
    Estimated
Fair Value
 
 

 

 

   

 

 

 

Cash and cash equivalents

    $ 195,058      $ 195,058        $ 206,348      $ 206,348   

Securities, available-for-sale

    67,815        67,815        100,195        100,195   

Loans held for sale

        2,262,085            2,262,085            3,175,272        3,175,272   

Loans held for sale from discontinued operations

    296        296        302        302   

Loans held for investment, net

    7,967,322        7,962,217        6,711,198            6,714,031   

Derivative asset

    13,886        13,886        28,473        28,473   

Deposits

    8,957,081        8,958,305        7,440,804        7,441,240   

Federal funds purchased

    169,794        169,794        273,179        273,179   

Borrowings

    279,930        279,931        1,673,982        1,673,983   

Subordinated notes

    111,000        98,130        111,000        112,757   

Trust preferred subordinated debentures

    113,406        113,406        113,406        113,406   

Derivative liability

    13,886        13,886        28,473        28,473   

 

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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 sheet for cash and cash equivalents approximate their fair value, which is characterized as a Level 1 asset in the fair value hierarchy.

Securities

The fair value of investment securities is based on prices obtained from independent pricing services which are based on quoted market prices for the same or similar securities, which is characterized as a Level 2 asset 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, net

Loans are characterized as Level 3 assets in the fair value hierarchy. For variable-rate loans 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 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. The carrying amount of loans held for sale approximates fair value.

Derivatives

The estimated fair value of the interest rate swaps are obtained from independent pricing services based on quote market prices for the same or similar derivative contracts and are characterized as a Level 2 asset in the fair value hierarchy. On a quarterly basis, we independently verify the fair value using an additional independent pricing source.

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, other borrowings, subordinated notes and trust preferred subordinated debentures

The carrying value reported in the consolidated balance sheet for Federal funds purchased and other short-term, floating rate borrowings approximates their fair value, which is characterized as a Level 1 asset 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, which is characterized as a Level 3 liability in the fair value hierarchy. The subordinated notes are publicly traded and are valued based on market prices, which is characterized as a Level 2 liability in the fair value hierarchy.

(11)  DERIVATIVE FINANCIAL INSTRUMENTS

The fair value of derivative positions outstanding is included in other assets and other liabilities in the accompanying consolidated balance sheets.

During 2013 and 2012, we entered into certain interest rate derivative positions that are not designated as hedging instruments. These derivative positions relate to transactions in which we enter into an interest rate swap, cap and/or floor with a customer while at the same time entering into an offsetting interest rate swap, cap and/or floor with another financial institution. In connection with each swap transaction, we agree to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows our customer to effectively convert a variable rate loan to a fixed rate. Because we act as an intermediary for our customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on our results of operations.

 

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The notional amounts and estimated fair values of interest rate derivative positions outstanding at September 30, 2013 and December 31, 2012 are presented in the following tables (in thousands):

 

    September 30, 2013     December 31, 2012  
    Notional
Amount
    Estimated Fair
Value
    Notional
Amount
    Estimated Fair
Value
 
 

 

 

   

 

 

 

Non-hedging interest rate derivative:

       

Commercial loan/lease interest rate swaps

    $ 719,755      $ 13,250      $ 523,216      $ 28,469   

Commercial loan/lease interest rate swaps

        (719,755)            (13,250)            (523,216)            (28,469)   

Commercial loan/lease interest rate caps

    (67,461)        (636)        (42,380)        (4)   

Commercial loan/lease interest rate caps

    67,461        636        42,380        4   

The weighted-average receive and pay interest rates for interest rate swaps outstanding at September 30, 2013 were as follows:

 

     September 30, 2013
Weighted-Average Interest Rate
    December 31, 2012
Weighted-Average Interest Rate
 
     Received     Paid     Received     Paid  

Non-hedging interest rate swaps

     4.89     3.17     4.76     3.11

The weighted-average strike rate for outstanding interest rate caps was 1.89% at September 30, 2013 and 2.06% at December 31, 2012.

Our credit exposure on interest rate swaps and caps is limited to the net favorable value and interest payments of all swaps and caps by each counterparty. In such cases collateral may be required from the counterparties involved if the net value of the swaps and caps exceeds a nominal amount considered to be immaterial. Our credit exposure, net of any collateral pledged, relating to interest rate swaps and caps was approximately $13.9 million at September 30, 2013 and approximately $28.5 million at December 31, 2012, all of which 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, 2013 and December 31, 2012, we had $12.3 million and $17.1 million, respectively, in cash collateral pledged for these derivatives included in interest-bearing deposits.

(12)  STOCKHOLDERS’ EQUITY

On August 1, 2012, we completed a sale of 2.3 million shares of our common stock in a public offering. Net proceeds from the sale totaled $87.0 million. The additional equity was used for general corporate purposes, including retirement of $15.0 million of debt and additional capital to support continued loan growth at our bank.

On March 28, 2013, we completed a sale of 6.0 million shares of 6.5% non-cumulative preferred stock, par value $0.01, with a liquidation preference of $25 per share, in a public offering. Dividends on the preferred stock are not cumulative and will be paid when declared by our board of directors to the extent that we have lawfully available funds to pay dividends. If declared, dividends will accrue and be payable quarterly, in arrears, on the liquidation preference amount, on a non-cumulative basis, at a rate of 6.50% per annum. We paid $2.4 million in dividends on the preferred stock on September 15, 2013. Holders of preferred stock will not have voting rights, except with respect to authorizing or increasing the authorized amount of senior stock, certain changes in the terms of the preferred stock, certain dividend non-payments and as otherwise required by applicable law. Net proceeds from the sale totaled $145.0 million. The additional equity is being used for general corporate purposes, including funding regulatory capital infusions into the Bank.

 

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(13)  NEW ACCOUNTING PRONOUNCEMENTS

ASU 2013-01, “Balance Sheet (Topic 210) – Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” (“ASU 2013-01”) amends Topic 210, “Balance Sheet” to clarify that the scope of ASU 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities” would apply to derivatives including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are offset in accordance with Topic 815, “Derivatives and Hedging”. ASU 2013-01 was effective January 1, 2013 and did not have a significant impact on our financial statements.

ASU 2013-02, “Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”) amends Topic 220, “Comprehensive Income” to improve the reporting of reclassifications out of accumulated other comprehensive income. Entities are required to separately present significant amounts reclassified out of accumulated other comprehensive income for each component of accumulated other comprehensive income and to disclose, for each affected line item in the income statement, the amount of accumulated other comprehensive income that has been reclassified into that line item. ASU 2013-02 was effective for fiscal years, and interim periods within those years, beginning after December 13, 2012 and did not have a significant impact on our financial statements.

 

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QUARTERLY FINANCIAL SUMMARY – UNAUDITED

Consolidated Daily Average Balances, Average Yields and Rates

(In thousands)

 

 
            For the three months ended                 For the three months ended      
            September 30, 2013             September 30, 2012      
    Average     Revenue/     Yield/     Average     Revenue/     Yield/  
    Balance     Expense(1)     Rate     Balance     Expense(1)     Rate  
 

 

 

 

Assets

           

Securities – taxable

    $ 54,838        $ 522        3.78%        $ 84,583        $ 881        4.14%   

Securities – non-taxable(2)

    16,879        246        5.78%        25,717        376        5.82%   

Federal funds sold

    78,896        22        0.11%        9,360        2        0.09%   

Deposits in other banks

    88,717        60        0.27%        64,859        54        0.33%   

Loans held for sale

    2,362,118        22,547        3.79%        2,432,027        24,433        4.00%   

Loans held for investment

    7,731,901        91,906        4.72%        6,313,263        76,397        4.81%   

Less reserve for loan losses

    79,551        -        -        72,373        -        -   
 

 

 

   

 

 

 

Loans, net of reserve

    10,014,468        114,453        4.53%        8,672,917        100,830        4.63%   
 

 

 

   

 

 

 

Total earning assets

    10,253,798        115,303        4.46%        8,857,436        102,143        4.59%   

Cash and other assets

    383,968            399,428       
 

 

 

       

 

 

     

Total assets

    $   10,637,766            $ 9,256,864       
 

 

 

       

 

 

     

Liabilities and Stockholders’ Equity

           

Transaction deposits

    $ 794,630        $ 102        0.05%        $ 803,776        $ 247        0.12%   

Savings deposits

    4,057,792        2,863        0.28%        2,922,852        2,185        0.30%   

Time deposits

    402,920        414        0.41%        491,783        576        0.47%   

Deposits in foreign branches

    357,532        320        0.36%        431,412        370        0.34%   
 

 

 

   

 

 

 

Total interest bearing deposits

    5,612,874        3,699        0.26%        4,649,823        3,378        0.29%   

Other borrowings

    539,767        275        0.20%        1,639,953        878        0.21%   

Subordinated notes

    111,000        1,829        6.54%        12,065        208        6.86%   

Trust preferred subordinated debentures

    113,406        638        2.23%        113,406        692        2.43%   
 

 

 

   

 

 

 

Total interest bearing liabilities

    6,377,047        6,441        0.40%        6,415,247        5,156        0.32%   

Demand deposits

    3,124,602            2,010,694       

Other liabilities

    89,640            80,810       

Stockholders’ equity

    1,046,477            750,113       
 

 

 

       

 

 

     

Total liabilities and stockholders’ equity

    $ 10,637,766            $   9,256,864       
 

 

 

       

 

 

     
   

 

 

       

 

 

   

Net interest income

      $       108,862            $       96,987     
   

 

 

       

 

 

   

Net interest margin

        4.21%            4.36%   

Net interest spread

        4.06%            4.27%   

Additional information from discontinued operations:

  

         

Loans held for sale

    $ 297            $ 384       

Borrowed funds

    297            384       

Net interest income

      $ 8            $ 5     

Net interest margin - consolidated

        4.21%            4.36%   

 

(1)

The loan averages include loans on which the accrual of interest has been discontinued and are stated net of unearned income.

(2)

Taxable equivalent rates used where applicable.

 

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QUARTERLY FINANCIAL SUMMARY – UNAUDITED

Consolidated Daily Average Balances, Average Yields and Rates

(In thousands)

 

 
            For the nine months ended                 For the nine months ended      
            September 30, 2013                 September 30, 2012      
    Average     Revenue/     Yield/     Average     Revenue/     Yield/  
    Balance     Expense(1)     Rate     Balance     Expense(1)     Rate  
 

 

 

 

Assets

           

Securities – taxable

    $ 61,980        $ 1,845        3.98%        $ 95,031        $ 2,870        4.03%   

Securities – non-taxable(2)

    19,279        844        5.85%        27,009        1,178        5.83%   

Federal funds sold

    52,908        41        0.10%        8,100        7        0.12%   

Deposits in other banks

    86,241        172        0.27%        58,272        151        0.35%   

Loans held for sale

    2,377,001        67,628        3.80%        2,177,963        66,835        4.10%   

Loans held for investment

    7,245,587        256,425        4.73%        5,976,291        220,060        4.92%   

Less reserve for loan losses

    76,352        -        -        71,474        -        -   
 

 

 

   

 

 

 

Loans, net of reserve

    9,546,236        324,053        4.54%        8,082,780        286,895        4.74%   
 

 

 

   

 

 

 

Total earning assets

    9,766,644        326,955        4.48%        8,271,192        291,101        4.70%   

Cash and other assets

    396,122            391,464       
 

 

 

       

 

 

     

Total assets

    $   10,162,766            $ 8,662,656       
 

 

 

       

 

 

     

Liabilities and Stockholders’ Equity

           

Transaction deposits

    $ 949,089        $ 588        0.08%        $ 688,276        $ 585        0.11%   

Savings deposits

    3,551,267        7,452        0.28%        2,708,406        6,375        0.31%   

Time deposits

    401,300        1,235        0.41%        566,788        2,327        0.55%   

Deposits in foreign branches

    344,585        897        0.35%        428,448        1,045        0.33%   
 

 

 

   

 

 

 

Total interest bearing deposits

    5,246,241        10,172        0.26%        4,391,918        10,332        0.31%   

Other borrowings

    767,661        1,058        0.18%        1,538,915        2,333        0.20%   

Subordinated notes

    111,000        5,487        6.61%        4,051        208        6.86%   

Trust preferred subordinated debentures

    113,406        1,905        2.25%        113,406        2,091        2.46%   
 

 

 

   

 

 

 

Total interest bearing liabilities

    6,238,308        18,622        0.40%        6,048,290        14,964        0.33%   

Demand deposits

    2,858,468            1,859,069       

Other liabilities

    90,592            76,145       

Stockholders’ equity

    975,398            679,152       
 

 

 

       

 

 

     

Total liabilities and stockholders’ equity

    $ 10,162,766            $   8,662,656       
 

 

 

       

 

 

     
   

 

 

       

 

 

   

Net interest income

      $       308,333            $       276,137     
   

 

 

       

 

 

   

Net interest margin

        4.22%            4.46%   

Net interest spread

        4.08%            4.37%   

Additional information from discontinued operations:

  

         

Loans held for sale

    $ 299            $ 388       

Borrowed funds

    299            388       

Net interest income

      $ 20            $ 19     

Net interest margin - consolidated

        4.22%            4.46%   

 

(1) The loan averages include loans on which the accrual of interest has been discontinued 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

Statements and financial analysis contained in this document that are not historical facts are forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (the “Act”). In addition, certain statements may be contained in our future filings with SEC, in press releases, and in oral and written statements made by or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Forward looking statements describe our future plans, strategies and expectations and are based on certain assumptions. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements, and include statements related to our business strategy, financial condition, revenue, liquidity and sources of capital, the effects of government regulation applicable to our operations, including the determination of our capital ratio, the appropriateness of our allowance and provisions for loan losses and the collectability of loans.

Forward-looking statements involve risks and uncertainties, many of which are beyond our control that may cause actual results to differ materially from those in such statements. The important factors that could cause actual results to differ materially from the forward looking statements include are disclosed under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 and include, but are not limited to, the following:

 

   

Changes in interest rates and the relationship between rate indices, including LIBOR and Fed funds;

 

   

Changes in the levels of loan prepayments, which could affect the value of our loans or investment securities;

 

   

Changes in general economic and business conditions in areas or markets where we compete;

 

   

Competition from banks and other financial institutions for loans and customer deposits;

 

   

The failure of assumptions underlying the establishment of and provisions made to the allowance for credit losses and differences in assumptions utilized by banking regulators which could have retroactive impact;

 

   

The loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels;

 

   

Changes in government regulations, state and federal laws, or policies affecting one or more of our business segments, including regulations promulgated pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act;

 

   

Potential losses resulting from claims and litigation, whether founded or unfounded, if not resolved in a manner favorable to us;

 

   

Adverse changes in the default rate of our loans and our failure to effectively manage our credit risk; and

 

   

Adverse changes in cost and availability of capital.

Forward-looking statements speak only as of the date on which such statements are made. We have no obligation to update or revise any forward-looking statements as a result of new information or future events. In light of these assumptions, risks and uncertainties, the events discussed in any forward-looking statements in this quarterly report might not occur.

 

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Results of Operations

Except as otherwise noted, all amounts and disclosures throughout this document reflect continuing operations. See Part I, Item 1 herein for a discussion of discontinued operations at Note (9) – Discontinued Operations.

Summary of Performance

We reported net income of $33.5 million and net income available to common shareholders of $31.0 million, or $0.74 per diluted common share, for the third quarter of 2013 compared to net income and net income available to common shareholders of $32.5 million, or $.80 per diluted common share, for the third quarter of 2012. The dividend on preferred shares reduced income available to common shareholders by $2.4 million, or $0.06 per share, during the third quarter of 2013. Return on average common equity was 13.74% and return on average assets was 1.25% for the third quarter of 2013, compared to 17.27% and 1.40%, respectively, for the third quarter of 2012. Net income and net income available to common shareholders for the nine months ended September 30, 2013 totaled $90.7 million and $85.7 million, respectively, or $2.05 per diluted common share, compared to net income and net income available to common shareholders of $89.2 million, or $2.25 per diluted common share, for the same period in 2012. Return on average common equity was 13.14% and return on average assets was 1.19% for the nine months ended September 30, 2013, compared to 17.56% and 1.38%, respectively, for the nine months ended September 30, 2012.

Net income increased $904,000, or 3%, for the three months ended September 30, 2013 as compared to the same period in 2012. The $904,000 increase during the three months ended September 30, 2013, was primarily the result of a $11.9 million increase in net interest income, offset by a $2.0 million increase in the provision for credit losses, a $121,000 decrease in non-interest income, an $8.5 million increase in non-interest expense and a $408,000 increase in income tax expense. The $1.4 million increase in net income during the nine months ended September 30, 2013 was primarily the result of a $32.3 million increase in net interest income, a $2.6 million increase in non-interest income and a $139,000 decrease in income tax expense, offset by a $7.0 million increase in the provision for credit losses and a $26.6 million increase in non-interest expense.

Details of the changes in the various components of net income are further discussed below.

Net Interest Income

Net interest income was $108.8 million for the third quarter of 2013, compared to $96.9 million for the third quarter of 2012. The increase was due to an increase in average earning assets of $1.4 billion as compared to the third quarter of 2012. The increase in average earning assets included a $1.4 billion increase in average loans held for investment, offset by a $69.9 million decrease in loans held for sale and a $38.6 million decrease in average securities. For the quarter ended September 30, 2013, average net loans and securities represented 98% and 1%, respectively, of average earning assets compared to 98% and 1% in the same quarter of 2012.

Average interest bearing liabilities for the quarter ended September 30, 2013 decreased $38.2 million from the third quarter of 2012, which included a $963.1 million increase in interest bearing deposits and a $98.9 million increase in subordinated notes, offset by a $1.1 billion decrease in other borrowings. Demand deposits increased from $2.0 billion at September 30, 2012 to $3.1 billion at September 30, 2013. The average cost of interest bearing deposits decreased from .29% for the quarter ended September 30, 2012 to .26% for the same period of 2013. The change in funding composition decreased the cost of interest bearing deposits and borrowed funds to .26% in the third quarter of 2013 compared to .27% in the third quarter of 2012.

Net interest income was $308.0 million for the nine months ended September 30, 2013, compared to $275.7 million for the same period of 2012. The increase was due to an increase in average earning assets of $1.5 billion as compared to the nine months ended September 30, 2012. The increase in average earning assets included a $1.3 billion increase in average loans held for investment and a $199.0 million increase in loans held for sale, offset by a $40.8 million decrease in average securities. For the nine months ended September 30, 2013, average net loans and securities represented 98% and 1%, respectively, of average earning assets compared to 98% and 1% in the same quarter of 2012.

Average interest bearing liabilities for the nine months ended September 30, 2013 increased $190.0 million compared to the first nine months of 2012, which included a $854.3 million increase in interest bearing deposits and a $106.9 million increase in subordinated notes, offset by a $771.3 million decrease in other borrowings. Demand deposits increased from $1.9 billion at September 30, 2012 to $2.9 billion at September

 

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30, 2013. The average cost of interest bearing deposits decreased from .31% for the nine months ended September 30, 2012 to .26% for the same period of 2013. The change in funding composition decreased the cost of interest bearing deposits and borrowed funds to .25% for the nine months ended September 30, 2013 compared to .29% in the same period of 2012.

The following table presents the changes (in thousands) in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities.

 

                                                                                                                 
    Three months ended     Nine months ended  
    September 30, 2013/2012     September 30, 2013/2012  
 

 

 

 
    Net     Change Due To(1)     Net     Change Due To(1)  
    Change     Volume     Yield/Rate     Change     Volume     Yield/Rate  
 

 

 

 

Interest income:

           

Securities(2)

    $ (489)      $ (437)      $ (52)      $ (1,359)      $ (1,338)      $ (21)   

Loans held for sale

    (1,886)        (680)        (1,206)        793        5,666        (4,873)   

Loans held for investment

    15,509        17,449        (1,940)        36,365        46,437        (10,072)   

Federal funds sold

    20        15        5        34        39        (5)   

Deposits in other banks

    6        20        (14)        21        72        (51)   
 

 

 

 

Total

    13,160        16,367        (3,207)        35,854        50,876        (15,022)   

Interest expense:

           

Transaction deposits

    (145)        (3)        (142)        3        221        (218)   

Savings deposits

    678        859        (181)        1,077        1,971        (894)   

Time deposits

    (162)        (103)        (59)        (1,092)        (680)        (412)   

Deposits in foreign branches

    (50)        (63)        13        (148)        (205)        57   

Borrowed funds

    964        1,123        (159)        3,818        4,316        (498)   
 

 

 

 

Total

    1,285        1,813        (528)        3,658        5,623        (1,965)   
 

 

 

 

Net interest income

    $ 11,875      $ 14,554      $ (2,679)      $ 32,196      $ 45,253      $ (13,057)   
 

 

 

 

 

(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 used where applicable.

Net interest margin, the ratio of net interest income to average earning assets, was 4.21% for the third quarter of 2013 compared to 4.36% for the third quarter of 2012. This 15 basis point decrease was the result of a decrease in interest income as a percent of earning assets offset by a reduction in funding costs. Funding cost including demand deposits and borrowed funds decreased from ..20% for the third quarter of 2012 to .17% for the third quarter of 2013. The cost of subordinated debt issued in September 2012 and the trust preferred as a percent of total earning assets was .10% for the third quarter of 2013. Total cost of funding, including all deposits and stockholders’ equity increased slightly to .24% for the third quarter of 2013 compared to .22% for the third quarter of 2012.

Non-interest Income

The components of non-interest income were as follows (in thousands):

 

                                                                                                   
    Three months ended
September 30,
    Nine months ended
September 30,
 
    2013     2012     2013     2012  
 

 

 

 

Service charges on deposit accounts

    $ 1,659      $ 1,684      $ 5,109      $ 4,912   

Trust fee income

    1,263        1,216        3,773        3,562   

Bank owned life insurance (BOLI) income

    423        549        1,384        1,658   

Brokered loan fees

    4,078        4,839        13,600        12,618   

Swap fees

    983        1,397        3,616        2,815   

Other

    2,025        867        5,358        4,639   
 

 

 

 

Total non-interest income

    $ 10,431      $ 10,552      $ 32,840      $ 30,204   
 

 

 

 

 

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Non-interest income decreased $121,000 during the three months ended September 30, 2013 compared to the same period of 2012. This decrease is primarily related to a decrease of $761,000 in brokered loan fees due to a slowdown in our mortgage finance volume. Swap fee income decreased $414,000 during the three months ended September 30, 2013 compared to the same period of 2012 due to a decrease in swap transactions. Swap fees are fees related to customer swap transactions and are received from the institution that is our counterparty on the transaction. See Note 11 – Derivative Financial Instruments for further discussion. Offsetting these decreases was a $1.2 million increase in other non-interest income.

Non-interest income increased $2.6 million during the nine months ended September 30, 2013 compared to the same period of 2012. This increase is primarily related to an increase of $982,000 in brokered loan fees due to an increase in our mortgage finance volume. Swap fee income increased $801,000 during the nine months ended September 30, 2013 compared to the same period of 2012 due to an increase in swap transactions. Swap fees are fees related to customer swap transactions and are received from the institution that is our counterparty on the transaction. See Note 11 – Derivative Financial Instruments for further discussion.

While management expects continued growth in non-interest income, the future rate of growth could be affected by increased competition from nationwide and regional financial institutions. In order to achieve continued 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,
 
    2013     2012     2013     2012  
 

 

 

 

Salaries and employee benefits

    $ 36,012      $ 31,009      $ 114,744      $ 90,258   

Net occupancy expense

    4,342        3,653        12,334        10,936   

Marketing

    3,974        3,472        12,020        9,469   

Legal and professional

    3,937        4,916        12,584        12,237   

Communications and technology

    3,696        2,885        10,165        8,088   

Allowance and other carrying costs for OREO

    267        552        1,179        7,706   

FDIC insurance assessment

    4,357        1,332        6,134        4,497   

Other

    5,424        5,702        17,283        16,579   
 

 

 

 

Total non-interest expense

    $ 62,009      $ 53,521      $ 186,443      $ 159,770   
 

 

 

 

Non-interest expense for the third quarter of 2013 increased $8.5 million, or 16%, to $62.0 million from $53.5 million in the third quarter of 2012. The increase is primarily attributable to a $5.0 million increase in salaries and employee benefits due to general business growth.

Marketing expense for the three months ended September 30, 2013 increased $502,000, or 14%, compared to the same quarter in 2012, primarily due to general business growth and treasury management programs.

Legal and professional expense for the three months ended September 30, 2013 decreased $979,000 compared to the same quarter in 2012. Our legal and professional expense will continue to fluctuate and could increase in the future with growth and as we respond to continued regulatory changes and strategic initiatives.

FDIC insurance assessment expense for the three months ended September 30, 2013 increased $3.0 million compared to the same quarter in 2012 due to a $3.0 million assessment by the FDIC that was paid during the third quarter of 2013. The assessment related to the year-end call reports for 2011 and 2012, which were amended for the change in the risk weight applicable to our mortgage finance loan portfolio as described in Note 7. As previously disclosed, the amendment caused one capital ratio to fall below “well-capitalized” for each quarter end. We do not believe this is an assessment warranted under our circumstances, and we have disputed the charge. Any recovery of the $3.0 million expense would be credited to non-interest expense in a future quarter.

 

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Non-interest expense for the nine months ended September 30, 2013 increased $26.6 million, or 17%, to $186.4 million from $159.8 million compared to the same period in 2012. The increase is primarily attributable to a $24.4 million increase in salaries and employee benefits. Of this increase, approximately $7.7 million related to a charge taken to reflect the financial effect of the planned organizational change announced during the second quarter of 2013 related to the retirement and transition of our CEO and includes assumptions about future payouts that may or may not occur. These payouts, when and if realized, will be directly linked to our performance and stock price, but are required to be estimated at the time of the event. Additionally, there was another $2.2 million of charges related to the increased probability that certain company financial performance targets for executive cash-based incentives will be met. These incentives are expensed based on current stock prices. The remaining $14.5 million increase was primarily due to general business growth and incentive expense directly related to our performance and the increase in the price of our common stock.

Marketing expense for the nine months ended September 30, 2013 increased $2.6 million, or 27%, compared to the same period in 2012, which was primarily due to general business growth and treasury management programs.

Communications and data processing expense for the nine months ended September 30, 2013 increased $2.1 million compared to the same period in 2012 as a result of general business growth.

For the nine months ended September 30, 2013, allowance and other carrying costs for OREO decreased $6.5 million, to $1.2 million, $454,000 of which related to deteriorating values of assets held in OREO. Of the $454,000 valuation expense in the first nine months of 2013, $290,000 related to direct write-downs of the OREO balance and $164,000 related to increasing the valuation allowance.

FDIC insurance assessment expense for the nine months ended September 30, 2013 increased $1.6 million compared to the same period in 2012. Included in the year-to-date September 30, 2013 expense was a $3.0 million assessment by the FDIC that was paid during the third quarter of 2013. The assessment related to the year-end call reports for 2011 and 2012, which were amended for the change in the risk weight applicable to our mortgage finance loan portfolio as described in Note 7. As previously disclosed, the amendment caused one capital ratio to fall below “well-capitalized” for each quarter end. We do not believe this is an assessment warranted under our circumstances, and we have disputed the charge. Any recovery of the $3.0 million expense would be credited to non-interest expense in a future quarter.

Analysis of Financial Condition

Loan Portfolio

Total loans net of allowance for loan losses at September 30, 2013 increased $342.9 million from December 31, 2012 to $10.2 billion. All loan categories within loans held for investment increased for a combined $1.3 billion increase. Loans held for sale decreased $913.2 million from December 31, 2012 as a result of seasonal trends and rising long-term interest rates.

Loans were as follows as of the dates indicated (in thousands):

 

                                                       
     September 30,     December 31,  
     2013     2012  
  

 

 

 

Commercial

     $ 4,782,234      $ 4,106,419   

Construction

     1,125,908        737,637   

Real estate

     2,087,058        1,892,451   

Consumer

     19,619        19,493   

Leases

     85,936        69,470   
  

 

 

 

Gross loans held for investment

     8,100,755        6,825,470   

Deferred income (net of direct origination costs)

     (49,427)        (39,935)   

Allowance for loan losses

     (84,006)        (74,337)   
  

 

 

 

Total loans held for investment, net

     7,967,322        6,711,198   

Loans held for sale

     2,262,085        3,175,272   
  

 

 

 

Total

     $ 10,229,407      $ 9,886,470   
  

 

 

 

 

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We continue to lend primarily in Texas. As of September 30, 2013, a substantial majority of the principal amount of the loans held for investment in our portfolio was to businesses and successful professionals and entrepreneurs in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions in Texas. The risks created by these concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses. Management believes the allowance for loan losses is appropriate to cover estimated losses on loans at each balance sheet date.

We originate a substantial majority of all the loans held for investment. We also participate in syndicated loan relationships, both as a participant and as an agent. As of September 30, 2013, we have $1.3 billion in syndicated loans, $395.2 million of which we acted as agent. All syndicated loans, whether we act as agent or participant, are underwritten to the same standards as all other loans originated by us. In addition, as of September 30, 2013, none of our syndicated loans were on non-accrual.

Loans held for sale consist of legal ownership interests purchased in single-family residential mortgages funded through our mortgage finance group. These loans are typically on our balance sheet for 10 to 20 days or less. We have agreements with mortgage lenders and purchase legal ownership interest 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 or loans eligible for sale to federal agencies or government sponsored entities.

Summary of Loan Loss Experience

The provision for credit losses is a charge to earnings to maintain the reserve for loan losses at a level consistent with management’s assessment of the loan portfolio in light of current economic conditions and market trends. We recorded a provision of $5.0 million during the third quarter of 2013 compared to $3.0 million in the second quarter of 2012 and $7.0 million in the second quarter of 2013. Despite experiencing improvements in credit quality, we have seen levels of reserves and provision increase due to growth in the portfolio. We do continue to maintain an unallocated reserve component to allow for continued uncertainty in economic and other conditions affecting the quality of the loan portfolio. We believe the level of unallocated reserves at September 30, 2013 continues to be warranted due to the ongoing weak economic environment which has produced more frequent losses, including those resulting from fraud by borrowers.

The reserve for loan losses is comprised of specific reserves for impaired loans and an estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We regularly evaluate our reserve for loan losses to maintain an appropriate level to absorb estimated loan losses inherent in the loan portfolio. Factors contributing to the determination of reserves include the credit worthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All loan commitments rated substandard or worse and greater than $500,000 are specifically reviewed for loss potential. For loans deemed to be impaired, a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, the portfolio is segregated by product types to recognize differing risk profiles among categories, and then further segregated by credit grades. Credit grades are assigned to all loans. Each credit grade is assigned a risk factor, or reserve allocation percentage. These risk factors are multiplied by the outstanding principal balance and risk-weighted by product type to calculate the required reserve. A similar process is employed to calculate a reserve assigned to off-balance sheet commitments, specifically unfunded loan commitments and letters of credit. Even though portions of the allowance may be allocated to specific loans, the entire allowance is available for any credit that, in management’s judgment, should be charged off.

The reserve allocation percentages assigned to each credit grade have been developed based primarily on an analysis of our historical loss rates. The allocations are adjusted for certain qualitative factors for such things as general economic conditions, changes in credit policies and lending standards. Changes in the trend and severity of problem loans can cause the estimation of losses to differ from past experience. In addition, the reserve considers the results of reviews performed by independent third party reviewers as reflected in their confirmations of assigned credit grades within the portfolio. The portion of the allowance that is not derived by the allowance allocation percentages compensates 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 evaluate many factors and conditions in determining the unallocated portion of the allowance, including the economic and business conditions affecting key lending areas, credit quality trends and general growth in the portfolio. The allowance is considered appropriate, given management’s assessment of potential losses within the portfolio as of the evaluation date, the significant growth in the loan and lease portfolio, current economic conditions in the Company’s market areas and other factors.

 

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The methodology used in the periodic review of reserve adequacy, which is performed at least quarterly, is designed to be dynamic and responsive to changes in portfolio credit quality. The changes are reflected in the general reserve and in specific reserves as the collectability of larger classified loans are evaluated with new information. As our portfolio has matured, historical loss ratios have been closely monitored, and our reserve adequacy relies primarily on our loss history. The review of reserve adequacy is performed by executive management and presented to our board of directors for their review, consideration and ratification on a quarterly basis.

The combined reserve for credit losses, which includes a liability for losses on unfunded commitments, totaled $88.6 million at September 30, 2013, $78.2 million at December 31, 2012 and $77.2 million at September 30, 2012. Due to the growth in loans, the total reserve percentage decreased to 1.10% at September 30, 2013 from 1.15% and 1.18% of loans held for investment at December 31, 2012 and September 30, 2012, respectively. The total reserve percentage had increased in 2010 as a result of the effects of national and regional economic conditions on borrowers and values of assets pledged as collateral. The combined reserve percentage has trended down as we recognized losses on loans for which there were specific or general allocations of reserves and as we have experienced improvement in our overall credit quality. The overall reserve for loan losses continues to result from consistent application of the loan loss reserve methodology as described above. At September 30, 2013, we believe the reserve is sufficient to cover all expected losses in the portfolio and has been derived from consistent application of the methodology described above. Should any of the factors considered by management in evaluating the 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.

 

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Activity in the reserve for loan losses is presented in the following table (in thousands):

 

    

    Nine months ended    

September 30,

     Year ended
        December 31,        
     Nine months ended
September 30,
 
     2013      2012      2012  
  

 

 

 

Reserve for loan losses:

        

Beginning balance

     $ 74,337       $ 70,295       $ 70,295   

Loans charged-off:

        

Commercial

     4,970         6,708         2,664   

Real estate - term

     144         899         899   

Consumer

     45         49         49   

Equipment leases

     2         204         170   
  

 

 

 

Total charge-offs

     5,161         7,860         3,782   

Recoveries:

        

Commercial

     978         832         482   

Real estate - construction

     -         10         10   

Real estate - term

     210         812         586   

Consumer

     64         33         26   

Equipment leases

     279         108         87   
  

 

 

 

Total recoveries

     1,531         1,795         1,191   
  

 

 

 

Net charge-offs

     3,630         6,065         2,591   

Provision for loan losses

     13,299         10,107         6,018   
  

 

 

 

Ending balance

     $ 84,006       $ 74,337       $ 73,722   
  

 

 

 

Reserve for off-balance sheet credit losses:

        

Beginning balance

     $ 3,855       $ 2,462       $ 2,462   

Provision for off-balance sheet credit losses

     701         1,393         982   
  

 

 

 

Ending balance

     $ 4,556       $ 3,855       $ 3,444   
  

 

 

 

Total reserve for credit losses

     $ 88,562       $ 78,192       $ 77,166   

Total provision for credit losses

     $ 14,000       $ 11,500       $ 7,000   

Reserve for loan losses to loans held for investment(2)

     1.04%         1.10%         1.13%   

Net charge-offs to average loans(1) (2)

     0.07%         0.10%         0.06%   

Total provision for credit losses to average loans(2)

     0.26%         0.19%         0.24%   

Recoveries to total charge-offs

     29.66%         22.84%         31.49%   

Reserve for off-balance sheet credit losses to off-balance sheet credit commitments

     0.12%         0.14%         0.15%   

Combined reserves for credit losses to loans held for investment(2)

     1.10%         1.15%         1.18%   

Non-performing assets:

        

Non-accrual loans(5)

     $ 35,737       $ 55,833       $ 57,275   

OREO(4)

     12,805         15,991         19,079   

Other repossessed assets

     -         42         -  
  

 

 

 

Total

     $ 48,542       $ 71,866       $ 76,354   
  

 

 

 

Restructured loans

     $ 4,691       $ 10,407       $ 9,145   

Loans past due 90 days and still accruing(3)

     7,510         3,674         3,622   

Reserve as a percent of non-performing loans

     2.4x         1.3x         1.3x   

 

(1)

Interim period ratios are annualized.

(2)

Excludes loans held for sale.

(3)

At September 30, 2013, December 31, 2012 and September 30, 2012, loans past due 90 days and still accruing includes premium finance loans of $3.1 million, $2.8 million and $2.7 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.

(4)

At September 30, 2013, December 31, 2012 and September 30, 2012, OREO balance is net of $4.6 million, $5.6 million and $4.7 million valuation allowance, respectively.

(5)

As of September 30, 2013, December 31, 2012 and September 30, 2012, non-accrual loans included $24.2 million, $19.6 million and $14.7 million, respectively, in loans that met the criteria for restructured.

 

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Non-performing Assets

Non-performing assets include non-accrual loans and leases and repossessed assets. The table below summarizes our non-accrual loans by type (in thousands):

 

    

    September 30,    

2013

    

    December 31,    

2012

    

    September 30,    

2012

 
  

 

 

 

Non-accrual loans:

        

Commercial

     $ 20,994       $ 15,373       $ 17,653   

Construction

     -         17,217         19,249   

Real estate

     14,616         23,066         20,100   

Consumer

     70         57         60   

Leases

     57         120         213   
  

 

 

 

Total non-accrual loans

     $ 35,737       $ 55,833       $ 57,275   
  

 

 

 

The table below summarizes the non-accrual loans as segregated by loan type and type of property securing the credit as of September 30, 2013 (in thousands):

 

Non-accrual loans:

  

Commercial

  

Lines of credit secured by the following:

  

Various single family residences and notes receivable

   $ 2,176     

Oil and gas properties

     1,668     

Assets of the borrowers

     11,532     

Unimproved land

     4,448     

Other

     1,170     
  

 

 

 

Total commercial

     20,994     

Real estate

  

Secured by:

  

Commercial property

     5,938     

Unimproved land and/or undeveloped residential lots

     4,837     

Single family residences

     888     

Other

     2,953     
  

 

 

 

Total real estate

     14,616     

Consumer

     70     

Leases (commercial leases primarily secured by assets of the lessor)

     57     
  

 

 

 

Total non-accrual loans

     $           35,737     
  

 

 

 

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, 2013, none of our non-accrual loans were earning on a cash basis.

A loan 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. All loans classified as restructured loans are also considered impaired. Reserves on impaired loans are measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral.

At September 30, 2013, we had $7.5 million in loans past due 90 days and still accruing interest. At September 30, 2013, $3.1 million of the loans past due 90 days and still accruing are premium finance loans. These loans are primarily 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.

Restructured loans are loans on which, due to the borrower’s financial difficulties, we have granted a concession that we would not otherwise consider. 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

 

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potentially qualify as a restructuring include reduction of contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current rate for new debt with similar risk, or a reduction of the face amount of debt, or forgiveness of either principal or accrued interest. As of September 30, 2013, we had $4.7 million in loans considered restructured that are not on non-accrual. Of the non-accrual loans at September 30, 2013, $24.2 million met the criteria for restructured. A loan continues to qualify as restructured until a consistent payment history or change in borrower’s financial condition has been evidenced, generally no less than twelve months. 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, 2013, we had $18.7 million in loans of this type which were not included in either non-accrual or 90 days past due categories. We did not have any loans of this type at September 30, 2012.

The table below presents a summary of the activity related to OREO (in thousands):

 

     Three months ended September 30,      Nine months ended September 30,  
     2013      2012      2013      2012  
  

 

 

 

Beginning balance

     $ 13,053       $ 27,882       $ 15,991       $ 34,077   

Additions

     68         -         980         3,397   

Sales

     (316)         (8,739)         (3,712)         (12,467)   

Valuation allowance for OREO

     -         -         (164)         (3,556)   

Direct write-downs

     -         (64)         (290)         (2,372)   
  

 

 

 

Ending balance

     $ 12,805       $ 19,079       $ 12,805       $ 19,079   
  

 

 

 

The following table summarizes the assets held in OREO at September 30, 2013 (in thousands):

 

Unimproved commercial real estate lots and land

     $ 3,116     

Commercial buildings

     819     

Undeveloped land and residential lots

     7,200     

Single family residences

     611     

Other

     1,059     
  

 

 

 

Total OREO

     $             12,805     
  

 

 

 

When foreclosure occurs, fair value, which is generally based on appraised values, may result in partial charge-off of a loan upon taking property, and so long as property is retained, subsequent reductions in appraised values will result in valuation adjustment taken as non-interest expense. In addition, if the decline in value is believed to be permanent and not just driven by market conditions, a direct write-down to 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 related to the appraised values during that holding period. During the nine months ended September 30, 2013 and 2012, we recorded $454,000 and $5.9 million in valuation expense, respectively. Of the $454,000 recorded for the nine months ended September 30, 2013, $164,000 related to direct write-downs and $290,000 related to increasing the valuation allowance.

 

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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, which are formulated and monitored by our senior management and our Balance Sheet Management Committee (“BSMC”), and which take into account the demonstrated marketability of assets, the sources and stability of 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, 2012 and for nine months ended September 30, 2013, 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.

Our liquidity needs for support of growth in loans held for investment have been fulfilled through growth in our core customer deposits. Our goal is to obtain as much of our funding for loans held for investment and other earnings assets as possible from deposits of these core customers. These deposits are generated principally through development of long-term relationships with customers and stockholders, 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 now categorized as brokered deposits; however, since these deposits arise from a customer relationship, we consider these deposits to be core deposits for our reporting purposes. 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 supplement temporary differences in the growth in loans, including growth in loans held for sale or other specific categories of loans, compared to customer deposits. The following table summarizes our period-end and average year-to-date core customer deposits and brokered deposits (in millions):

 

    

    September 30,    

2013

    

    September 30,    

2012

    

    December 31,    

2012

 
  

 

 

 

Deposits from core customers

   $ 7,526.5       $ 5,694.4       $ 6,448.8   

Deposits from core customers as a percent of total deposits

     84.0%         84.8%         86.7%   

Relationship brokered deposits

   $ 1,430.6       $ 955.5       $ 992.0   

Relationship brokered deposits as a percent of total deposits

     16.0%         14.2%         13.3%   

Traditional brokered deposits

   $ -       $ 67.7       $ -   

Traditional brokered deposits as a percent of total deposits

     0.0%         1.0%         0.0%   

Average deposits from core customers(1)

   $ 6,799.0       $ 5,282.0       $ 5,483.3   

Average deposits from core customers as a percent of total quarterly average deposits(1)

     83.9%         84.5%         85.1%   

Average relationship brokered deposits(1)

   $ 1,305.7       $ 831.6       $ 852.7   

Average relationship brokered deposits as a percent of total quarterly average deposits(1)

     16.1%         13.3%         13.2%   

Average traditional brokered deposits(1)

   $ -       $ 137.3       $ 108.0   

Average traditional brokered deposits as a percent of total quarterly average deposits(1)

     0.0%         2.2%         1.7%   

 

(1) Annual averages presented for December 31, 2012.

We have access to, and have periodically utilized, sources of brokered deposits of not less than an additional $3.5 billion. Customer deposits (total deposits, including relationship brokered deposits, minus brokered CDs) increased by $2.3 billion from September 30, 2012 and increased by $1.5 billion from December 31, 2012.

 

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Additionally, we have borrowing sources available to supplement deposits and meet our funding needs. Such borrowings are generally used to fund our loans held for sale, due to their liquidity, short duration and interest spreads available. These borrowing sources typically 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 borrowings as of September 30, 2013 (in thousands):

 

Federal funds purchased

     $ 169,794   

Customer repurchase agreements

     29,899   

FHLB borrowings

     250,031   

Subordinated notes

     111,000   

Trust preferred subordinated debentures

     113,406   
  

 

 

 

Total borrowings

     $ 674,130   
  

 

 

 

Maximum borrowings outstanding at any month-end during the year

     $       1,859,036   
  

 

 

 

The following table summarizes our other borrowing capacities in excess of balances outstanding at September 30, 2013 (in thousands):

   

FHLB borrowing capacity relating to loans

     $ 1,144,965   

FHLB borrowing capacity relating to securities

     9,921   
  

 

 

 

Total FHLB borrowing capacity

     $       1,154,886   
  

 

 

 
  
  

 

 

 

Unused federal funds lines available from commercial banks

     $ 894,000   
  

 

 

 

Our equity capital averaged $975.4 million for the nine months ended September 30, 2013, as compared to $679.2 million for the same period in 2012. We have not paid any cash dividends on our common stock since we commenced operations and have no plans to do so in the near future.

Our capital ratios remain above the levels required to be well capitalized and have been enhanced with the additional capital raised since 2008 and will allow us to grow organically with the addition of loan and deposit relationships.

At December 31, 2012, we had a non-revolving amortizing line of credit with $35.0 million of unused capacity. During the first quarter of 2013, we modified the line of credit to increase the capacity to $50.0 million and that line matures on October 31, 2013. 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. At September 30, 2013, no borrowings were outstanding.

During the second quarter of 2012, we filed a Registration Statement on Form S-3 with the SEC which was effective June 25, 2012. The registration statement covered issuances of up to $250.0 million of debt or equity securities. On August 1, 2012, we completed a sale of 2.3 million shares of our common stock in a public offering. Net proceeds from the sale totaled $87.0 million. The additional equity was used for general corporate purposes, including retirement of $15.0 million of debt discussed above and additional capital to support continued loan growth at our bank.

On September 21, 2012, we issued $111.0 million of subordinated notes in a public offering. The notes mature in September 2042 and bear interest at a rate of 6.50% per annum, payable quarterly. The proceeds were used for general corporate purposes including funding regulatory capital infusions into the Bank. The loan agreement contains customary financial covenants and restrictions.

During the fourth quarter of 2012, we filed a Registration Statement on Form S-3 with the SEC which was effective October 25, 2012. The registration statement covers issuances of up to $250.0 million of debt or equity securities. On March 28, 2013, we completed a sale of 6.0 million shares of our preferred stock in a public offering. Net proceeds from the sale totaled $145.1 million. The additional equity is being used for general corporate purposes, including funding regulatory capital infusions into the Bank.

 

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Commitments and Contractual Obligations

The following table presents significant fixed and determinable contractual 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, 2013, our significant fixed and determinable contractual obligations to third parties were as follows (in thousands):

 

            After One but      After Three but                
     Within One      Within Three      Within Five      After Five         
     Year      Years      Years      Years      Total  
  

 

 

 

Deposits without a stated maturity(1)

     $ 8,189,197       $ -       $ -       $ -       $ 8,189,197   

Time deposits(1)

     737,877         27,360         2,575         72         767,884   

Federal funds purchased(1)

     169,794         -         -         -         169,794   

Customer repurchase agreements(1)

     29,899         -         -         -         29,899   

FHLB borrowings(1)

     250,000         -         31         -         250,031   

Operating lease obligations(1) (2)

     12,129         24,906         24,217         56,723         117,975   

Subordinated notes(1)

     -         -         -         111,000         111,000   

Trust preferred subordinated debentures(1)

     -         -         -         113,406         113,406   
  

 

 

 

Total contractual obligations

     $         9,388,896       $         52,266       $ 26,823       $         281,201       $         9,749,186   
  

 

 

 

 

(1) Excludes interest.
(2) Non-balance sheet item.

Critical Accounting Policies

SEC guidance requires disclosure of “critical accounting policies.” The SEC defines “critical accounting policies” as those that are most important to the presentation of a company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States. The more significant of these policies are summarized in Note 1 to the consolidated financial statements. Not all these significant accounting policies require management to make difficult, subjective or complex judgments. However, the policy noted below could be deemed to meet the SEC’s definition of critical accounting policies.

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 loan 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 credit-worthiness of the borrower, and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. For purposes of determining the general reserve, the portfolio is segregated by product types in order to recognize differing risk profiles among categories, and then further segregated by credit grades. See “Summary of Loan Loss Experience” 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. The effect of other changes, such as 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 Balance Sheet Management Committee, 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. Compliance with these guidelines is the ongoing responsibility of the BSMC, with exceptions reported to our board of directors on a quarterly basis.

Interest Rate Risk Management

Our interest rate sensitivity is illustrated in the following table. The table reflects rate-sensitive positions as of September 30, 2013, 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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Interest Rate Sensitivity Gap Analysis

September 30, 2013

(In thousands)