Edgar Filing: TEXAS CAPITAL BANCSHARES INC/TX

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10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



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

For the quarterly period ended September 30, 2015



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

For the transition period from to

Commission file number 001-34657

TEXAS CAPITAL BANCSHARES, INC.

(Exact Name of Registrant as Specified in Its Charter)



Delaware		75-2679109
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)



2000 McKinney Avenue, Suite 700, Dallas, Texas, U.S.A.		75201
(Address of principal executive officers)		(Zip Code)

214/932-6600

(Registrant’s telephone number,

including area code)

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “large accelerated filer” and “accelerated filer” Rule 12b-2 of the Exchange Act.

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

On October 21, 2015, 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 45,844,361

Table of Contents

Texas Capital Bancshares, Inc.

Form 10-Q

Quarter Ended September 30, 2015

Index



Part I. Financial Information

Item 1.	Financial Statements
	Consolidated Balance Sheets—Unaudited	3
	Consolidated Statements of Income and Other Comprehensive Income—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	28
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	45

Item 4.	Controls and Procedures	48

Part II. Other Information

Item 1.	Legal Proceedings	48

Item 1A.	Risk Factors	48

Item 6.	Exhibits	49
Signatures		50

Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TEXAS CAPITAL BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands except share data)



	September 30, 2015			December 31, 2014
	(Unaudited)
Assets
Cash and due from banks	$	101,758		$	96,524
Interest-bearing deposits	2,320,192			1,233,990
Federal funds sold and securities purchased under resale agreements	25,000			—
Securities, available-for-sale	31,998			41,719
Loans held for sale, at fair value	1,062			—
Loans held for investment, mortgage finance	4,312,790			4,102,125
Loans held for investment (net of unearned income)	11,562,828			10,154,887
Less: Allowance for loan losses	130,540			100,954
Loans held for investment, net	15,745,078			14,156,058
Premises and equipment, net	17,772			17,368
Accrued interest receivable and other assets	403,040			333,699
Goodwill and intangible assets, net	20,095			20,588
Total assets	$	18,665,995		$	15,899,946
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Non-interest-bearing	$	6,545,273		$	5,011,619
Interest-bearing	8,620,072			7,348,972
Interest-bearing in foreign branches	—			312,709
Total deposits	15,165,345			12,673,300
Accrued interest payable	2,694			4,747
Other liabilities	154,665			145,622
Federal funds purchased and repurchase agreements	103,834			92,676
Other borrowings	1,250,000			1,100,005
Subordinated notes	286,000			286,000
Trust preferred subordinated debentures	113,406			113,406
Total liabilities	17,075,944			14,415,756
Stockholders’ equity:
Preferred stock, $.01 par value, $1,000 liquidation value:
Authorized shares – 10,000,000
Issued shares – 6,000,000 shares issued at September 30, 2015 and December 31, 2014	150,000			150,000
Common stock, $.01 par value:
Authorized shares – 100,000,000
Issued shares – 45,839,781 and 45,735,424 at September 30, 2015 and December 31, 2014, respectively	458			457
Additional paid-in capital	713,209			709,738
Retained earnings	725,502			622,714
Treasury stock (shares at cost: 417 at September 30, 2015 and December 31, 2014)	(8		)	(8		)
Accumulated other comprehensive income, net of taxes	890			1,289
Total stockholders’ equity	1,590,051			1,484,190
Total liabilities and stockholders’ equity	$	18,665,995		$	15,899,946

See accompanying notes to consolidated 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,
	2015			2014			2015			2014
Interest income
Interest and fees on loans	$	151,749		$	134,618		$	442,529		$	374,724
Securities	298			428			979			1,439
Federal funds sold and securities purchased under resale agreements	193			68			427			116
Deposits in other banks	1,616			176			4,203			435
Total interest income	153,856			135,290			448,138			376,714
Interest expense
Deposits	6,240			4,606			17,510			12,882
Federal funds purchased	56			82			217			292
Repurchase agreements	6			5			14			13
Other borrowings	672			68			1,590			321
Subordinated notes	4,191			4,241			12,573			11,961
Trust preferred subordinated debentures	643			627			1,892			1,862
Total interest expense	11,808			9,629			33,796			27,331
Net interest income	142,048			125,661			414,342			349,383
Provision for credit losses	13,750			6,500			39,250			15,500
Net interest income after provision for credit losses	128,298			119,161			375,092			333,883
Non-interest income
Service charges on deposit accounts	2,096			1,817			6,339			5,277
Trust fee income	1,222			1,190			3,709			3,714
Bank owned life insurance (BOLI) income	484			517			1,444			1,547
Brokered loan fees	4,885			3,821			14,394			10,002
Swap fees	254			464			3,275			2,098
Other	2,439			2,587			7,257			8,647
Total non-interest income	11,380			10,396			36,418			31,285
Non-interest expense
Salaries and employee benefits	48,583			43,189			142,611			125,141
Net occupancy expense	5,874			5,279			17,373			15,120
Marketing	3,999			4,024			12,142			11,578
Legal and professional	5,510			4,874			15,176			17,457
Communications and technology	5,180			4,928			15,905			13,213
FDIC insurance assessment	4,489			2,775			12,490			8,044
Allowance and other carrying costs for OREO	1			5			16			61
Other	8,052			6,841			23,768			20,383
Total non-interest expense	81,688			71,915			239,481			210,997
Income before income taxes	57,990			57,642			172,029			154,171
Income tax expense	20,876			20,810			61,928			55,653
Net income	37,114			36,832			110,101			98,518
Preferred stock dividends	2,438			2,438			7,313			7,313
Net income available to common stockholders	$	34,676		$	34,394		$	102,788		$	91,205
Other comprehensive income (loss)
Change in net unrealized gain on available-for-sale securities arising during period, before-tax	$	(216	)	$	(295	)	$	(613	)	$	(414	)
Income tax benefit related to net unrealized gain on available-for-sale securities	(75		)	(103		)	(214		)	(145		)
Other comprehensive loss, net of tax	(141		)	(192		)	(399		)	(269		)
Comprehensive income	$	36,973		$	36,640		$	109,702		$	98,249

Basic earnings per common share	$	0.76		$	0.80		$	2.24		$	2.13
Diluted earnings per common share	$	0.75		$	0.78		$	2.21		$	2.09

See accompanying notes to consolidated financial statements.

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TEXAS CAPITAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY - UNAUDITED

(In thousands except share data)



	Preferred Stock			Common Stock									Treasury Stock
	Shares	Amount		Shares	Amount		Additional Paid-in Capital			Retained Earnings			Shares		Amount			Accumulated Other Comprehensive Income (Loss), Net of Taxes			Total
Balance at December 31, 2013	6,000,000	$	150,000	41,036,787	$	410	$	448,208		$	496,112		(417	)	$	(8	)	$	1,628		$	1,096,350
Comprehensive income:
Net income	—	—		—	—		—			98,518			—		—			—			98,518
Change in unrealized gain on available-for-sale securities, net of taxes of $145	—	—		—	—		—			—			—		—			(269		)	(269		)
Total comprehensive income																					98,249
Tax benefit related to exercise of stock-based awards	—	—		—	—		2,534			—			—		—			—			2,534
Stock-based compensation expense recognized in earnings	—	—		—	—		3,628			—			—		—			—			3,628
Issuance of preferred stock	—	—		—	—		—			—			—		—			—			—
Preferred stock dividend	—	—		—	—		—			(7,313		)	—		—			—			(7,313		)
Issuance of stock related to stock-based awards	—	—		168,535	2		(2,076		)	—			—		—			—			(2,074		)
Issuance of common stock	—	—		1,875,000	19		106,529			—			—		—			—			106,548
Issuance of common stock related to warrants	—	—		99,229	1		(1		)	—			—		—			—			—
Balance at September 30, 2014	6,000,000	$	150,000	43,179,551	$	432	$	558,822		$	587,317		(417	)	$	(8	)	$	1,359		$	1,297,922

Balance at December 31, 2014	6,000,000	$	150,000	45,735,424	$	457	$	709,738		$	622,714		(417	)	$	(8	)	$	1,289		$	1,484,190
Comprehensive income:
Net income	—	—		—	—		—			110,101			—		—			—			110,101
Change in unrealized gain on available-for-sale securities, net of taxes of $215	—	—		—	—		—			—			—		—			(399		)	(399		)
Total comprehensive income																					109,702
Tax benefit related to exercise of stock-based awards	—	—		—	—		1,092			—			—		—			—			1,092
Stock-based compensation expense recognized in earnings	—	—		—	—		3,328			—			—		—			—			3,328
Preferred stock dividend	—	—		—	—		—			(7,313		)	—		—			—			(7,313		)
Issuance of stock related to stock-based awards	—	—		104,357	1		(949		)	—			—		—			—			(948		)
Balance at September 30, 2015	6,000,000	$	150,000	45,839,781	$	458	$	713,209		$	725,502		(417	)	$	(8	)	$	890		$	1,590,051

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,
	2015			2014
Operating activities
Net income from continuing operations	$	110,101		$	98,518
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses	39,250			15,500
Depreciation and amortization	12,230			10,583
Bank owned life insurance (BOLI) income	(1,444		)	(1,547		)
Stock-based compensation expense	9,286			11,690
Excess tax expense from stock-based compensation arrangements	(1,134		)	(2,534		)
Net increase in loans held for sale, including proceeds from sales and repayments	(1,062		)	—
(Gain) loss on sale of assets	134			(821		)
Changes in operating assets and liabilities:
Accrued interest receivable and other assets	(77,873		)	(13,762		)
Accrued interest payable and other liabilities	2,339			(1,166		)
Net cash provided by operating activities	91,827			116,461
Investing activities
Maturities and calls of available-for-sale securities	2,430			11,150
Principal payments received on available-for-sale securities	6,677			7,712
Originations of mortgage finance loans	(66,786,322		)	(40,244,845		)
Proceeds from pay-offs of mortgage finance loans	66,575,657			39,254,648
Net increase in loans held for investment, excluding mortgage finance loans	(1,417,605		)	(1,206,606		)
Purchase (disposal) of premises and equipment, net	(3,729		)	(9,110		)
Proceeds from sale of foreclosed assets	1,430			5,823
Net cash used in investing activities	(1,621,462		)	(2,181,228		)
Financing activities
Net increase in deposits	2,492,045			2,458,429
Net expense from issuance of stock related to stock-based awards	(948		)	(2,074		)
Net proceeds from issuance of common stock	—			106,548
Preferred dividends paid	(7,313		)	(7,313		)
Net increase (decrease) in other borrowings	149,995			(397,462		)
Excess tax benefits from stock-based compensation arrangements	1,134			2,534
Net increase in Federal funds purchased and repurchase agreements	11,158			107,521
Net proceeds from issuance of subordinated notes	—			172,375
Net cash provided by financing activities	2,646,071			2,440,558
Net increase in cash and cash equivalents	1,116,436			375,791
Cash and cash equivalents at beginning of period	1,330,514			153,911
Cash and cash equivalents at end of period	$	2,446,950		$	529,702
Supplemental disclosures of cash flow information:
Cash paid during the period for interest	$	35,849		$	26,172
Cash paid during the period for income taxes	70,208			51,722
Transfers from loans/leases to OREO and other repossessed assets	1,177			851

See accompanying notes to consolidated financial statements.

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TEXAS CAPITAL BANCSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—UNAUDITED

(1) OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Nature of Business

Texas Capital Bancshares, Inc. (the “Company”), a Delaware corporation, was incorporated in November 1996 and commenced banking operations in December 1998. The consolidated financial statements of the Company include the accounts of Texas Capital Bancshares, Inc. and its wholly owned subsidiary, Texas Capital Bank, National Association (the “Bank”). We serve the needs of commercial businesses and successful professionals and entrepreneurs located in Texas as well as operate several lines of business serving a regional and national clientele of commercial borrowers. We are primarily a secured lender, with our greatest concentration of loans in Texas.

Basis of Presentation

Our accounting and reporting policies conform to accounting principles generally accepted in the United States (“GAAP”) and to generally accepted practices within the banking industry. Certain prior period balances have been reclassified to conform to the current period presentation.

The consolidated interim financial statements have been prepared without audit. Certain information and footnote disclosures presented in accordance with GAAP have been condensed or omitted. In the opinion of management, the interim financial statements include all normal and recurring adjustments and the disclosures made are adequate to make the interim financial information not misleading. The consolidated financial statements have been prepared in accordance with GAAP for interim financial information and the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2014, included in our Annual Report on Form 10-K filed with the SEC on February 19, 2015 (the “2014 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.

Loans Held for Sale

Through our Mortgage Correspondent Aggregation ("MCA") program, we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to government sponsored entities ("GSEs") such as Fannie Mae, Freddie Mac or Ginnie Mae. In some cases, we retain the mortgage servicing rights. Once purchased, these loans are classified as held for sale and are carried at fair value pursuant to our election of the fair value option in accordance with ASC 825 "Financial Instruments". At the commitment date, we enter into a corresponding forward sale commitment with a third party, typically a GSE, to deliver the loans within a specified timeframe. The estimated gain/loss for the entire transaction (from initial purchase commitment to final delivery of loans) is recorded as an asset or liability. Fair value is derived from observable current market prices, when available, and includes the fair value of the mortgage servicing rights. Adjustments to reflect unrealized gains and losses resulting from changes in fair value and realized gains and losses upon ultimate sale of the loans are classified as non-interest income in the Consolidated Statements of Income and Other Comprehensive Income.

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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,
	2015		2014		2015		2014
Numerator:
Net income	$	37,114	$	36,832	$	110,101	$	98,518
Preferred stock dividends	2,438		2,438		7,313		7,313
Net income available to common stockholders	34,676		34,394		$	102,788	91,205
Denominator:
Denominator for basic earnings per share— weighted average shares	45,827,902		43,143,580		45,792,470		42,842,143
Effect of employee stock-based awards(1)	216,499		284,859		216,448		333,690
Effect of warrants to purchase common stock	426,989		421,399		416,574		464,305
Denominator for dilutive earnings per share—adjusted weighted average shares and assumed conversions	46,471,390		43,849,838		46,425,492		43,640,138
Basic earnings per common share	$	0.76	$	0.80	$	2.24	$	2.13
Diluted earnings per common share	$	0.75	$	0.78	$	2.21	$	2.09


(1)	Stock options, SARs and RSUs outstanding of 101,100 at September 30, 2015 and 50,500 at September 30, 2014 have not been included in diluted earnings per share because to do so would have been anti-dilutive for the periods presented.

(3) SECURITIES

At September 30, 2015, our net unrealized gain on the available-for-sale securities portfolio was $1.4 million compared to $2.0 million at December 31, 2014. As a percent of outstanding balances, the unrealized gain was 4.47% and 4.99% at September 30, 2015, and December 31, 2014, respectively. The decrease in the unrealized gain percentage at September 30, 2015 is related to the reduction in the portfolio balance due to paydowns and maturities.

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



	September 30, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale securities:
Residential mortgage-backed securities	$	22,278	$	1,556	$	—		$	23,834
Municipals	828		3		—			831
Equity securities(1)	7,522		23		(212		)	7,333
	$	30,628	$	1,582	$	(212	)	$	31,998

	December 31, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale securities:
Residential mortgage-backed securities	$	28,957	$	2,108	$	—		$	31,065
Municipals	3,257		10		—			3,267
Equity securities(1)	7,522		16		(151		)	7,387
	$	39,736	$	2,134	$	(151	)	$	41,719


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

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



	September 30, 2015
	Less Than One Year			After One Through Five Years			After Five Through Ten Years			After Ten Years			Total
Available-for-sale:
Residential mortgage-backed securities:(1)
Amortized cost	$	64		$	5,730		$	4,567		$	11,917		$	22,278
Estimated fair value	64			5,972			5,089			12,709			23,834
Weighted average yield(3)	5.65		%	4.75		%	5.54		%	2.41		%	3.66		%
Municipals:(2)
Amortized cost	265			563			—			—			828
Estimated fair value	265			566			—			—			831
Weighted average yield(3)	5.46		%	5.69		%	—			—			5.62		%
Equity securities:(4)
Amortized cost	7,522			—			—			—			7,522
Estimated fair value	7,333			—			—			—			7,333
Total available-for-sale securities:
Amortized cost													$	30,628
Estimated fair value													$	31,998

Table of Contents



	December 31, 2014
	Less Than One Year			After One Through Five Years			After Five Through Ten Years			After Ten Years			Total
Available-for-sale:
Residential mortgage-backed securities:(1)
Amortized cost	$	1		$	9,151		$	5,661		$	14,144		$	28,957
Estimated fair value	1			9,662			6,333			15,069			31,065
Weighted average yield(3)	6.50		%	4.79		%	5.54		%	2.36		%	3.75		%
Municipals:(2)
Amortized cost	1,669			1,588			—			—			3,257
Estimated fair value	1,674			1,593			—			—			3,267
Weighted average yield(3)	5.78		%	5.79		%	—		%	—		%	5.79		%
Equity securities:(4)
Amortized cost	7,522			—			—			—			7,522
Estimated fair value	7,387			—			—			—			7,387
Total available-for-sale securities:
Amortized cost													$	39,736
Estimated fair value													$	41,719


(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 $22.5 million were pledged to secure certain borrowings and deposits at September 30, 2015. Of the pledged securities at September 30, 2015, approximately $7.2 million were pledged for certain deposits, and approximately $15.3 million were pledged for repurchase agreements.

The following table discloses, as of September 30, 2015 and December 31, 2014, our investment securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months (in thousands):



September 30, 2015	Less Than 12 Months				12 Months or Longer					Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Equity securities	$	—	$	—	$	6,288	$	(212	)	$	6,288	$	(212	)

December 31, 2014	Less Than 12 Months				12 Months or Longer					Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Equity securities	$	—	$	—	$	6,349	$	(151	)	$	6,349	$	(151	)

At September 30, 2015, we owned one security with an unrealized loss position. This security is a publicly traded equity fund and is subject to market pricing volatility. We do not believe this unrealized loss is “other-than-temporary”. We have evaluated the near-term prospects of the investment in relation to the severity and duration of the impairment and based on that evaluation have the ability and intent to hold the investment until recovery of fair value.

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(4) LOANS HELD FOR INVESTMENT AND ALLOWANCE FOR LOAN LOSSES

At September 30, 2015 and December 31, 2014, loans held for investment were as follows (in thousands):



	September 30, 2015			December 31, 2014
Commercial	$	6,553,639		$	5,869,219
Mortgage finance	4,312,790			4,102,125
Construction	1,864,178			1,416,405
Real estate	3,058,574			2,807,127
Consumer	24,757			19,699
Leases	118,644			99,495
Gross loans held for investment	15,932,582			14,314,070
Deferred income (net of direct origination costs)	(56,964		)	(57,058		)
Allowance for loan losses	(130,540		)	(100,954		)
Total loans held for investment	$	15,745,078		$	14,156,058

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 and take into account the risk of oil and gas price volatility. Our commercial loans and leases are underwritten after carefully evaluating and understanding the borrower’s ability to operate profitably. Our underwriting standards are designed to promote relationship banking rather than to make loans on a 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.

Mortgage Finance Loans. Our mortgage finance loans consist of ownership interests purchased in single-family residential mortgages funded through our mortgage finance group. These interests are typically on our balance sheet for 10 to 20 days. We have agreements with mortgage lenders and purchase interests in individual loans they originate. All loans are underwritten consistent with established programs for permanent financing with financially sound investors. Substantially all loans are conforming loans. Balances as of September 30, 2015 and December 31, 2014 are stated net of $425.0 million and $358.3 million participations sold, respectively.

Construction Loans. Our construction loan portfolio consists primarily of single- and multi-family residential properties and commercial projects used in manufacturing, warehousing, service or retail businesses. Our construction loans generally have terms of one to three years. We typically make construction loans to developers, builders and contractors that have an established record of successful project completion and loan repayment and have a substantial equity investment in the borrowers. Loan amounts are derived primarily from the bank's evaluation of expected cash flows available to service debt from stabilized projects under hypothetically stressed conditions. Construction loans are also based in part upon estimates of costs and value associated with the completed project. Sources of repayment for these types of loans may be pre-committed permanent loans from other lenders, sales of developed property or an interim loan commitment from us until permanent financing is obtained. The nature of these loans makes ultimate repayment sensitive to overall economic conditions. Borrowers may not be able to correct conditions of default in loans, increasing risk of exposure to classification, non-performing status, reserve allocation and actual credit loss and foreclosure. These loans typically have floating rates and commitment fees.

Real Estate Loans. A portion of our real estate loan portfolio is comprised of loans secured by properties other than market risk or investment-type real estate. Market risk loans are real estate loans where the primary source of repayment is expected to come from the sale, permanent financing or lease of the real property collateral. We generally provide temporary financing for commercial and residential property. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Our real estate loans generally have maximum terms of five to seven years, and we provide loans with both floating and fixed rates. We generally avoid long-term loans for commercial real estate held for investment. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Appraised values may be highly variable due to market conditions, the impact of the inability of potential purchasers and lessees to obtain financing and a lack of transactions at comparable values.

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At September 30, 2015 and December 31, 2014, we had a blanket floating lien on certain real estate-secured loans, mortgage finance loans and certain securities used as collateral for Federal Home Loan Bank (“FHLB”) borrowings.

Portfolio Geographic Concentration

As of September 30, 2015, a substantial majority of our loans held for investment, excluding our mortgage finance loans and other national lines of business, were to businesses with headquarters and operations in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. Additionally, we may make loans to these businesses and individuals secured by assets located outside of Texas. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for loan losses. Management believes the allowance for loan losses is appropriate to cover probable losses inherent in the loan portfolio at each balance sheet date.

Summary of Loan Loss Experience

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 the current 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 insufficiently protected by the current 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, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high. All doubtful loans are on non-accrual.

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 and 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 reflects the results of reviews performed by the Company's independent Credit Review function as reflected in their confirmations of assigned credit grades within the portfolio. The Credit Review function reports to the Credit Risk Committee of the Company's board of directors with administrative oversight from the Company's Chief Risk Officer. 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. Examples of risks that support the Company's maintaining an unallocated reserve include the possibility of precipitous negative changes in economic conditions and borrowers' submission of financial statements or certifications of collateral value that subsequently prove to be materially inaccurate for reason of either misstatement or omission of critical information. These situations, while not common, do not necessarily correlate well with the general risk profile presented by assigned credit grade and product type categories. We evaluate many factors and conditions in determining the unallocated portion of the allowance, including amount and frequency of losses attributable to issues not specifically addressed or included in the determination and application of the allowance allocation percentages. We consider the allowance to be appropriate, given management’s assessment of probable 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 appropriateness, 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 appropriateness relies primarily on our loss history. The review of reserve appropriateness is performed by executive management and presented to a committee of our board of directors for their review. The committee reports to the board as part of the board’s review on a quarterly basis of the Company’s consolidated financial statements.

The following tables summarize the credit risk profile of our loan portfolio by internally assigned grades and non-accrual status as of September 30, 2015 and December 31, 2014 (in thousands):



September 30, 2015
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Grade:
Pass	$	6,244,334	$	4,312,790	$	1,845,094	$	3,014,205	$	24,497	$	110,295	$	15,551,215
Special mention	113,542		—		1,771		23,076		26		2,650		141,065
Substandard-accruing	115,565		—		564		14,265		234		—		130,628
Non-accrual	80,198		—		16,749		7,028		—		5,699		109,674
Total loans held for investment	$	6,553,639	$	4,312,790	$	1,864,178	$	3,058,574	$	24,757	$	118,644	$	15,932,582

December 31, 2014
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Grade:
Pass	$	5,738,474	$	4,102,125	$	1,414,671	$	2,785,804	$	19,579	$	91,044	$	14,151,697
Special mention	53,839		—		1,734		8,723		11		4,363		68,670
Substandard-accruing	43,784		—		—		2,653		47		3,915		50,399
Non-accrual	33,122		—		—		9,947		62		173		43,304
Total loans held for investment	$	5,869,219	$	4,102,125	$	1,416,405	$	2,807,127	$	19,699	$	99,495	$	14,314,070

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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, 2015 and September 30, 2014. 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, 2015
(in thousands)	Commercial		Mortgage Finance		Construction			Real Estate			Consumer		Leases			Unallocated			Total
Beginning balance	$	70,654	$	—	$	7,935		$	15,582		$	240	$	1,141		$	5,402		$	100,954
Provision for loan losses	48,689		—		(3,944		)	(4,328		)	154		(221		)	(1,622		)	38,728
Charge-offs	11,278		—		—			346			62		25			—			11,711
Recoveries	2,098		—		397			28			19		27			—			2,569
Net charge-offs (recoveries)	9,180		—		(397		)	318			43		(2		)	—			9,142
Ending balance	$	110,163	$	—	$	4,388		$	10,936		$	351	$	922		$	3,780		$	130,540
Period end amount allocated to:
Loans individually evaluated for impairment	$	9,304	$	—	$	—		$	254		$	—	$	1		$	—		$	9,559
Loans collectively evaluated for impairment	100,859		—		4,388			10,682			351		921			3,780			120,981
Ending balance	$	110,163	$	—	$	4,388		$	10,936		$	351	$	922		$	3,780		$	130,540

September 30, 2014
(in thousands)	Commercial		Mortgage Finance		Construction			Real Estate			Consumer		Leases			Unallocated			Total
Beginning balance	$	39,868	$	—	$	14,553		$	24,210		$	149	$	3,105		$	5,719		$	87,604
Provision for loan losses	20,900		—		(1,611		)	(6,095		)	112		(1,480		)	2,044			13,870
Charge-offs	8,518		—		—			296			101		—			—			8,915
Recoveries	3,480		—		—			45			66		172			—			3,763
Net charge-offs (recoveries)	5,038		—		—			251			35		(172		)	—			5,152
Ending balance	$	55,730	$	—	$	12,942		$	17,864		$	226	$	1,797		$	7,763		$	96,322
Period end amount allocated to:
Loans individually evaluated for impairment	$	5,999	$	—	$	—		$	660		$	—	$	2		$	—		$	6,661
Loans collectively evaluated for impairment	49,731		—		12,942			17,204			226		1,795			7,763			89,661
Ending balance	$	55,730	$	—	$	12,942		$	17,864		$	226	$	1,797		$	7,763		$	96,322

We have traditionally maintained an unallocated reserve component to compensate for the uncertainty and complexity in estimating loan and lease losses including factors and conditions that may not be fully reflected in the determination and application of the allowance allocation percentages. We believe the level of unallocated reserves at September 30, 2015 is warranted due to the continued uncertain economic environment which has produced losses, including those resulting from borrowers' misstatement of financial information or inaccurate certification of collateral values. Such losses are not necessarily correlated with historical loss trends or general economic conditions. Our methodology used to calculate the allowance considers historical losses; however, the historical loss rates for specific product types or credit risk grades may not fully incorporate the effects of continued weakness in the economy.

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Our recorded investment in loans as of September 30, 2015, December 31, 2014 and September 30, 2014 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, 2015
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	82,050	$	—	$	16,749	$	9,895	$	—	$	5,699	$	114,393
Loans collectively evaluated for impairment	6,471,589		4,312,790		1,847,429		3,048,679		24,757		112,945		15,818,189
Total	$	6,553,639	$	4,312,790	$	1,864,178	$	3,058,574	$	24,757	$	118,644	$	15,932,582

December 31, 2014
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	35,165	$	—	$	—	$	13,880	$	62	$	173	$	49,280
Loans collectively evaluated for impairment	5,834,054		4,102,125		1,416,405		2,793,247		19,637		99,322		14,264,790
Total	$	5,869,219	$	4,102,125	$	1,416,405	$	2,807,127	$	19,699	$	99,495	$	14,314,070

September 30, 2014
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	27,109	$	—	$	—	$	17,904	$	—	$	10	$	45,023
Loans collectively evaluated for impairment	5,594,227		3,774,467		1,640,596		2,344,614		16,502		101,317		13,471,723
Total	$	5,621,336	$	3,774,467	$	1,640,596	$	2,362,518	$	16,502	$	101,327	$	13,516,746

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, 2015, $884,000 of our non-accrual loans were earning on a cash basis compared to $310,000 at December 31, 2014. A loan is placed back on accrual status when both principal and interest are current and it is probable that we will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.

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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 ("ASC 310"), we have also included all restructured loans in our impaired loan totals. The following tables detail our impaired loans, by portfolio class, as of September 30, 2015 and December 31, 2014 (in thousands):



September 30, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial
Business loans	$	16,370	$	24,185	$	—	$	18,211	$	—
Energy	35,304		35,304		—		16,991		28
Construction
Market risk	16,749		16,749		—		7,444		—
Real estate
Market risk	3,591		3,591		—		3,671		—
Commercial	2,909		2,909		—		3,467		16
Secured by 1-4 family	—		—		—