Edgar Filing: TEXAS CAPITAL BANCSHARES INC/TX

Document

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 June 30, 2017



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

For the transition period from to

Commission file number 001-34657

TEXAS CAPITAL BANCSHARES, INC.

(Exact Name of Registrant as Specified in Its Charter)



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



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

214/932-6600

(Registrant’s telephone number,

including area code)

N/A

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

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

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

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



Large Accelerated Filer	ý		Accelerated Filer	¨

Non-Accelerated Filer	¨	(Do not check if a smaller reporting company)	Smaller Reporting Company	¨

Emerging Growth Company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

On July 19, 2017, the number of shares set forth below was outstanding with respect to each of the issuer’s classes of common stock:

Common Stock, par value $0.01 per share 49,600,286

Table of Contents

Texas Capital Bancshares, Inc.

Form 10-Q

Quarter Ended June 30, 2017

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	30
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
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

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TEXAS CAPITAL BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands except share data)



	June 30, 2017			December 31, 2016
	(Unaudited)
Assets
Cash and due from banks	$	126,977		$	113,707
Interest-bearing deposits	2,117,658			2,700,645
Federal funds sold and securities purchased under resale agreements	25,000			25,000
Securities, available-for-sale	119,043			24,874
Loans held for sale ($843.2 million and $968.9 million at June 30, 2017 and December 31, 2016, respectively, at fair value )	846,017			968,929
Loans held for investment, mortgage finance	5,183,600			4,497,338
Loans held for investment (net of unearned income)	14,280,353			13,001,011
Less: Allowance for loan losses	174,225			168,126
Loans held for investment, net	19,289,728			17,330,223
Mortgage servicing rights, net	63,023			28,536
Premises and equipment, net	20,750			19,775
Accrued interest receivable and other assets	492,240			465,933
Goodwill and intangible assets, net	19,277			19,512
Total assets	$	23,119,713		$	21,697,134
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Non-interest-bearing	$	8,174,830		$	7,994,201
Interest-bearing	9,117,393			9,022,630
Total deposits	17,292,223			17,016,831
Accrued interest payable	6,246			5,498
Other liabilities	163,836			161,223
Federal funds purchased and repurchase agreements	462,224			109,575
Other borrowings	2,700,000			2,000,000
Subordinated notes, net	281,225			281,044
Trust preferred subordinated debentures	113,406			113,406
Total liabilities	21,019,160			19,687,577
Stockholders’ equity:
Preferred stock, $.01 par value, $1,000 liquidation value:
Authorized shares – 10,000,000
Issued shares – 6,000,000 shares issued at June 30, 2017 and December 31, 2016	150,000			150,000
Common stock, $.01 par value:
Authorized shares – 100,000,000
Issued shares – 49,595,669 and 49,504,079 at June 30, 2017 and December 31, 2016, respectively	496			495
Additional paid-in capital	957,721			955,468
Retained earnings	991,949			903,187
Treasury stock (shares at cost: 417 at June 30, 2017 and December 31, 2016)	(8		)	(8		)
Accumulated other comprehensive income, net of taxes	395			415
Total stockholders’ equity	2,100,553			2,009,557
Total liabilities and stockholders’ equity	$	23,119,713		$	21,697,134

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 June 30,						Six months ended June 30,
	2017			2016			2017			2016
Interest income
Interest and fees on loans	$	201,646		$	168,064		$	378,270		$	323,949
Securities	287			246			512			507
Federal funds sold and securities purchased under resale agreements	434			382			964			754
Deposits in other banks	5,824			3,750			12,391			7,035
Total interest income	208,191			172,442			392,137			332,245
Interest expense
Deposits	16,533			8,971			29,826			17,793
Federal funds purchased	726			110			978			236
Other borrowings	2,901			1,367			4,922			2,532
Subordinated notes	4,191			4,191			8,382			8,382
Trust preferred subordinated debentures	881			734			1,711			1,450
Total interest expense	25,232			15,373			45,819			30,393
Net interest income	182,959			157,069			346,318			301,852
Provision for credit losses	13,000			16,000			22,000			46,000
Net interest income after provision for credit losses	169,959			141,069			324,318			255,852
Non-interest income
Service charges on deposit accounts	3,067			2,411			6,112			4,521
Wealth management and trust fee income	1,402			1,098			2,759			1,911
Bank owned life insurance (BOLI) income	481			536			947			1,072
Brokered loan fees	5,809			5,864			11,487			10,509
Servicing income	3,700			50			5,901			(5		)
Swap fees	954			1,105			2,757			1,412
Other	3,356			2,868			5,916			5,809
Total non-interest income	18,769			13,932			35,879			25,229
Non-interest expense
Salaries and employee benefits	63,154			54,810			126,157			106,182
Net occupancy expense	6,515			5,838			12,626			11,650
Marketing	6,157			4,486			11,107			8,394
Legal and professional	7,127			6,226			14,580			11,550
Communications and technology	11,906			6,391			18,412			12,608
FDIC insurance assessment	4,603			6,043			10,597			11,512
Servicing related expenses	2,682			612			4,432			685
Other	9,670			9,849			19,997			18,494
Total non-interest expense	111,814			94,255			217,908			181,075
Income before income taxes	76,914			60,746			142,289			100,006
Income tax expense	25,819			21,866			48,652			35,998
Net income	51,095			38,880			93,637			64,008
Preferred stock dividends	2,437			2,437			4,875			4,875
Net income available to common stockholders	$	48,658		$	36,443		$	88,762		$	59,133
Other comprehensive income (loss)
Change in net unrealized gain on available-for-sale securities arising during period, before-tax	$	(33	)	$	(22	)	$	(30	)	$	(58	)
Income tax benefit related to net unrealized gain on available-for-sale securities	(11		)	(8		)	(10		)	(20		)
Other comprehensive loss, net of tax	(22		)	(14		)	(20		)	(38		)
Comprehensive income	$	51,073		$	38,866		$	93,617		$	63,970

Basic earnings per common share	$	0.98		$	0.79		$	1.79		$	1.29
Diluted earnings per common share	$	0.97		$	0.78		$	1.77		$	1.27

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, 2015 (audited)	6,000,000	$	150,000	45,874,224	$	459	$	714,546		$	757,818		(417	)	$	(8	)	$	718		$	1,623,533
Comprehensive income:
Net income	—	—		—	—		—			64,008			—		—			—			64,008
Change in unrealized gain on available-for-sale securities, net of taxes of $20	—	—		—	—		—			—			—		—			(38		)	(38		)
Total comprehensive income																					63,970
Tax benefit related to exercise of stock-based awards	—	—		—	—		450			—			—		—			—			450
Stock-based compensation expense recognized in earnings	—	—		—	—		2,243			—			—		—			—			2,243
Preferred stock dividend	—	—		—	—		—			(4,875		)	—		—			—			(4,875		)
Issuance of stock related to stock-based awards	—	—		79,104	1		(587		)	—			—		—			—			(586		)
Balance at June 30, 2016	6,000,000	$	150,000	45,953,328	$	460	$	716,652		$	816,951		(417	)	$	(8	)	$	680		$	1,684,735

Balance at December 31, 2016 (audited)	6,000,000	$	150,000	49,504,079	$	495	$	955,468		$	903,187		(417	)	$	(8	)	$	415		$	2,009,557
Comprehensive income:
Net income	—	—		—	—		—			93,637			—		—			—			93,637
Change in unrealized gain on available-for-sale securities, net of taxes of $10	—	—		—	—		—			—			—		—			(20		)	(20		)
Total comprehensive income																					93,617
Stock-based compensation expense recognized in earnings	—	—		—	—		3,461			—			—		—			—			3,461
Preferred stock dividend	—	—		—	—		—			(4,875		)	—		—			—			(4,875		)
Issuance of stock related to stock-based awards	—	—		57,995	1		(1,208		)	—			—		—			—			(1,207		)
Issuance of common stock related to warrants	—	—		33,595	—		—			—			—		—			—			—
Balance at June 30, 2017	6,000,000	$	150,000	49,595,669	$	496	$	957,721		$	991,949		(417	)	$	(8	)	$	395		$	2,100,553

See accompanying notes to consolidated financial statements.

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TEXAS CAPITAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS—UNAUDITED

(In thousands)



	Six months ended June 30,
	2017			2016
Operating activities
Net income	$	93,637		$	64,008
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses	22,000			46,000
Depreciation and amortization	12,346			10,446
Increase in valuation allowance on mortgage servicing rights	—			414
Bank owned life insurance (BOLI) income	(947		)	(1,072		)
Stock-based compensation expense	8,954			3,725
Excess tax benefits from stock-based compensation arrangements	—			(553		)
Purchases and originations of loans held for sale	(2,843,690		)	(876,516		)
Proceeds from sales and repayments of loans held for sale	2,939,002			734,964
Loss on sale of loans held for sale and other assets	93			12
Technology write-off	5,285			—
Changes in operating assets and liabilities:
Accrued interest receivable and other assets	(46,025		)	(71,805		)
Accrued interest payable and other liabilities	(488		)	23,094
Net cash provided by (used in) operating activities	190,167			(67,283		)
Investing activities
Purchases of available-for-sale securities	(96,871		)	(783		)
Maturities and calls of available-for-sale securities	275			265
Principal payments received on available-for-sale securities	2,397			3,080
Originations of mortgage finance loans	(37,251,933		)	(45,811,787		)
Proceeds from pay-offs of mortgage finance loans	36,565,671			45,518,036
Net increase in loans held for investment, excluding mortgage finance loans	(1,297,460		)	(794,749		)
Purchase of premises and equipment, net	(4,194		)	(1,166		)
Proceeds from sale of foreclosed assets	272			62
Net cash used in investing activities	(2,081,843		)	(1,087,042		)
Financing activities
Net increase in deposits	275,392			1,618,946
Costs from issuance of stock related to stock-based awards and warrants	(1,207		)	(586		)
Preferred dividends paid	(4,875		)	(4,875		)
Net increase in other borrowings	700,000			519,463
Excess tax benefits from stock-based compensation arrangements	—			553
Net increase (decrease) in Federal funds purchased and repurchase agreements	352,649			(47,069		)
Net cash provided by (used in) financing activities	1,321,959			2,086,432
Net increase (decrease) in cash and cash equivalents	(569,717		)	932,107
Cash and cash equivalents at beginning of period	2,839,352			1,790,870
Cash and cash equivalents at end of period	$	2,269,635		$	2,722,977
Supplemental disclosures of cash flow information:
Cash paid during the period for interest	$	45,071		$	30,151
Cash paid during the period for income taxes	52,042			43,309
Transfers from loans/leases to OREO and other repossessed assets	—			18,540

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 clientèle of commercial borrowers. We are primarily a secured lender, with our greatest concentration of loans in Texas.

Basis of Presentation

Our accounting and reporting policies conform to accounting principles generally accepted in the United States (“GAAP”) and to generally accepted practices within the banking industry. Certain prior period balances have been reclassified to conform to the current period presentation. In that regard, ASU 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting," ("ASU 2016-09") became effective for us on January 1, 2017. ASU 2016-09 requires that excess tax benefits and deficiencies be recognized as a component of income taxes within the income statement. Additionally, ASU 2016-09 requires that all income tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows. Previously, income tax benefits at award settlement were reported as a reduction to operating cash flows and an increase to financing cash flows to the extent that those benefits exceeded the income tax benefits reported in earnings during the award's vesting period. We have elected to apply that change in cash flow presentation on a prospective basis. ASU 2016-09 also requires that companies make an accounting policy election regarding forfeitures, to either estimate the number of awards that are expected to vest or account for them when they occur. We have elected to recognize forfeitures as they occur. The impact of this change and that of the remaining provisions of ASU 2016-09 did not have a significant impact on our financial statements.

The consolidated interim financial statements have been prepared without audit. Certain information and footnote disclosures presented in accordance with GAAP have been condensed or omitted. In the opinion of management, the interim financial statements include all normal and recurring adjustments and the disclosures made are adequate to make the interim financial information not misleading. The consolidated financial statements have been prepared in accordance with GAAP for interim financial information and the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2016, included in our Annual Report on Form 10-K filed with the SEC on February 17, 2017 (the “2016 Form 10-K”). Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for loan losses, the fair value of stock-based compensation awards, the fair value of mortgage servicing rights ("MSRs") and the status of contingencies are particularly susceptible to significant change.

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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 June 30,				Six months ended June 30,
	2017		2016		2017		2016
Numerator:
Net income	$	51,095	$	38,880	$	93,637	$	64,008
Preferred stock dividends	2,437		2,437		4,875		4,875
Net income available to common stockholders	48,658		36,443		$	88,762	59,133
Denominator:
Denominator for basic earnings per share— weighted average shares	49,576,837		45,924,281		49,556,393		45,906,508
Effect of employee stock-based awards(1)	224,306		124,974		244,058		121,524
Effect of warrants to purchase common stock	428,527		388,877		432,660		368,574
Denominator for dilutive earnings per share—adjusted weighted average shares and assumed conversions	50,229,670		46,438,132		50,233,111		46,396,606
Basic earnings per common share	$	0.98	$	0.79	$	1.79	$	1.29
Diluted earnings per common share	$	0.97	$	0.78	$	1.77	$	1.27


(1)	SARs and RSUs outstanding of 6,200 at June 30, 2017 and 252,754 at June 30, 2016 have not been included in diluted earnings per share because to do so would have been anti-dilutive for the periods presented.

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(3) SECURITIES

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



	June 30, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale securities:
U.S. Treasuries	$	94,360	$	—	$	(5	)	$	94,355
Residential mortgage-backed securities	12,284		832		—			13,116
Equity securities(1)	11,790		150		(368		)	11,572
	$	118,434	$	982	$	(373	)	$	119,043

	December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale securities:
Residential mortgage-backed securities	$	14,680	$	972	$	—		$	15,652
Municipals	275		—		—			275
Equity securities(1)	9,280		27		(360		)	8,947
	$	24,235	$	999	$	(360	)	$	24,874


(1)	Equity securities consist of Community Reinvestment Act funds and investments related to our non-qualified deferred compensation plan.

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



	June 30, 2017
	Less Than One Year			After One Through Five Years			After Five Through Ten Years			After Ten Years			Total
Available-for-sale:
U.S. Treasuries:
Amortized cost	$	94,360		$	—		$	—		$	—		$	94,360
Estimated fair value	94,355			—			—			—			94,355
Weighted average yield(3)	0.92		%	—		%	—		%	—		%	0.92		%
Residential mortgage-backed securities:(1)
Amortized cost	423			723			2,697			8,441			12,284
Estimated fair value	433			748			2,999			8,936			13,116
Weighted average yield(3)	4.70		%	4.72		%	5.55		%	3.00		%	3.40		%
Equity securities:(4)
Amortized cost	11,790			—			—			—			11,790
Estimated fair value	11,572			—			—			—			11,572
Total available-for-sale securities:
Amortized cost													$	118,434
Estimated fair value													$	119,043

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	December 31, 2016
	Less Than One Year			After One Through Five Years			After Five Through Ten Years			After Ten Years			Total
Available-for-sale:
Residential mortgage-backed securities:(1)
Amortized cost	$	9		$	2,047		$	3,147		$	9,477		$	14,680
Estimated fair value	9			2,104			3,495			10,044			15,652
Weighted average yield(3)	5.50		%	4.70		%	5.55		%	2.84		%	3.68		%
Municipals:(2)
Amortized cost	275			—			—			—			275
Estimated fair value	275			—			—			—			275
Weighted average yield(3)	5.61		%	—		%	—		%	—		%	5.61		%
Equity securities:(4)
Amortized cost	9,280			—			—			—			9,280
Estimated fair value	8,947			—			—			—			8,947
Total available-for-sale securities:
Amortized cost													$	24,235
Estimated fair value													$	24,874


(1)	Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.


(2)	Yields have been adjusted to a tax equivalent basis assuming a 35% federal tax rate.


(3)	Yields are calculated based on amortized cost.


(4)	These equity securities do not have a stated maturity.

At June 30, 2017, securities with carrying values of $91.5 million and $8.5 million were pledged to secure certain deposits and repurchase agreements, respectively.

The following table discloses, as of June 30, 2017 and December 31, 2016, our investment securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months (in thousands):



June 30, 2017	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. Treasuries	$	82,380	$	(5	)	$	—	$	—		$	82,380	$	(5	)
Equity securities(1)	1,021		—			6,132		(368		)	7,153		(368		)
	$	83,401	$	(5	)	$	6,132	$	(368	)	$	89,533	$	(373	)

December 31, 2016	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Equity securities	$	1,015	$	(6	)	$	6,146	$	(354	)	$	7,161	$	(360	)


(1)	Less than 12 months unrealized loss amount not meaningful.

At June 30, 2017, we owned six securities in an unrealized loss position, four of which are U.S. Treasury securities which are subject to interest rate volatility. We do not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost bases. The remaining two securities are publicly traded equity funds and are subject to market pricing volatility. We do not believe these unrealized losses are “other-than-temporary” as of June 30, 2017. We have evaluated the near-term prospects of the investments in relation to the severity and duration of the impairment and based on that evaluation we have the ability and intent to hold the investments until recovery of fair value.

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

At June 30, 2017 and December 31, 2016, loans held for investment were as follows (in thousands):



	June 30, 2017			December 31, 2016
Commercial	$	8,250,952		$	7,291,545
Mortgage finance	5,183,600			4,497,338
Construction	2,242,562			2,098,706
Real estate	3,569,787			3,462,203
Consumer	39,122			34,587
Leases	274,863			185,529
Gross loans held for investment	19,560,886			17,569,908
Deferred income (net of direct origination costs)	(96,933		)	(71,559		)
Allowance for loan losses	(174,225		)	(168,126		)
Total loans held for investment	$	19,289,728		$	17,330,223

Commercial Loans and Leases. Our commercial loan portfolio is comprised of lines of credit for working capital and term loans and leases to finance equipment and other business assets. Our energy production loans are generally collateralized with proven reserves based on appropriate valuation standards and take into account the risk of oil and gas price volatility. Our commercial loans and leases are underwritten after carefully evaluating and understanding the borrower’s ability to operate profitably. Our underwriting standards are designed to promote relationship banking rather than to make loans on a transaction basis. Our lines of credit typically are limited to a percentage of the value of the assets securing the line. Lines of credit and term loans typically are reviewed annually, or more frequently, as needed, and are supported by accounts receivable, inventory, equipment and other assets of our clients’ businesses.

Mortgage Finance Loans. Our mortgage finance loans consist of ownership interests purchased in single-family residential mortgages funded through our mortgage finance group. These loans are typically held on our balance sheet for 10 to 20 days. We have agreements with mortgage lenders and purchase interests in individual loans they originate. All loans are underwritten consistent with established programs for permanent financing with financially sound investors. Substantially all loans are conforming loans. Balances as of June 30, 2017 and December 31, 2016 are stated net of $234.1 million and $839.0 million participations sold, respectively.

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

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

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At June 30, 2017 and December 31, 2016, we had a blanket floating lien on certain real estate-secured loans, mortgage finance loans and certain securities used as collateral for Federal Home Loan Bank (“FHLB”) borrowings.

Summary of Loan Loss Experience

The allowance for loan losses is comprised of general reserves, specific reserves for impaired loans and an additional qualitative reserve based on our estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We consider the allowance at June 30, 2017 to be appropriate, given management's assessment of losses inherent in the portfolio as of the evaluation date, the significant growth in the loan and lease portfolio, current economic conditions in our market areas and other factors.

The following tables summarize the credit risk profile of our loan portfolio by internally assigned grades and non-accrual status as of June 30, 2017 and December 31, 2016 (in thousands):



June 30, 2017
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Grade:
Pass	$	7,984,302	$	5,183,600	$	2,236,870	$	3,523,118	$	38,637	$	254,772	$	19,221,299
Special mention	43,223		—		5,692		26,290		369		2,666		78,240
Substandard-accruing	103,859		—		—		16,217		116		17,425		137,617
Non-accrual	119,568		—		—		4,162		—		—		123,730
Total loans held for investment	$	8,250,952	$	5,183,600	$	2,242,562	$	3,569,787	$	39,122	$	274,863	$	19,560,886

December 31, 2016
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Grade:
Pass	$	6,941,310	$	4,497,338	$	2,074,859	$	3,430,346	$	34,249	$	181,914	$	17,160,016
Special mention	69,447		—		10,901		21,932		—		3,532		105,812
Substandard-accruing	115,848		—		12,787		7,516		138		—		136,289
Non-accrual	164,940		—		159		2,409		200		83		167,791
Total loans held for investment	$	7,291,545	$	4,497,338	$	2,098,706	$	3,462,203	$	34,587	$	185,529	$	17,569,908

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The following table details activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2017 and 2016. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.



June 30, 2017
(in thousands)	Commercial		Mortgage Finance		Construction			Real Estate			Consumer			Leases			Additional Qualitative Reserve			Total
Beginning balance	$	128,768	$	—	$	13,144		$	19,149		$	241		$	1,124		$	5,700		$	168,126
Provision for loan losses	19,384		—		680			3,436			287			2,989			(2,559		)	24,217
Charge-offs	21,543		—		—			40			180			—			—			21,763
Recoveries	3,442		—		101			53			41			8			—			3,645
Net charge-offs (recoveries)	18,101		—		(101		)	(13		)	139			(8		)	—			18,118
Ending balance	$	130,051	$	—	$	13,925		$	22,598		$	389		$	4,121		$	3,141		$	174,225
Period end amount allocated to:
Loans individually evaluated for impairment	$	28,382	$	—	$	—		$	180		$	—		$	—		$	—		$	28,562
Loans collectively evaluated for impairment	101,669		—		13,925			22,418			389			4,121			3,141			145,663
Ending balance	$	130,051	$	—	$	13,925		$	22,598		$	389		$	4,121		$	3,141		$	174,225

June 30, 2016
(in thousands)	Commercial		Mortgage Finance		Construction			Real Estate			Consumer			Leases			Additional Qualitative Reserve			Total
Beginning balance	$	112,446	$	—	$	6,836		$	13,381		$	338		$	3,931		$	4,179		$	141,111
Provision for loan losses	44,324		—		758			1,423			(28		)	(2,531		)	1,710			45,656
Charge-offs	24,287		—		—			528			—			—			—			24,815
Recoveries	5,334		—		34			21			11			45			—			5,445
Net charge-offs (recoveries)	18,953		—		(34		)	507			(11		)	(45		)	—			19,370
Ending balance	$	137,817	$	—	$	7,628		$	14,297		$	321		$	1,445		$	5,889		$	167,397
Period end amount allocated to:
Loans individually evaluated for impairment	$	30,775	$	—	$	—		$	196		$	—		$	—		$	—		$	30,971
Loans collectively evaluated for impairment	107,042		—		7,628			14,101			321			1,445			5,889			136,426
Ending balance	$	137,817	$	—	$	7,628		$	14,297		$	321		$	1,445		$	5,889		$	167,397

The table below presents the activity in the portion of the allowance for credit losses related to losses on unfunded commitments for the three and six months ended June 30, 2017 and 2016 (in thousands). This liability is recorded in other liabilities in the consolidated balance sheet.



	Three months ended June 30,						Six months ended June 30,
	2017			2016			2017			2016
Beginning balance	$	10,847		$	10,216		$	11,422		$	9,011
Provision for off-balance sheet credit losses	(1,642		)	(861		)	(2,217		)	344
Ending balance	$	9,205		$	9,355		$	9,205		$	9,355

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We have traditionally maintained an additional qualitative reserve component to compensate for the uncertainty and complexity in estimating loan and lease losses including factors and conditions that may not be fully reflected in the determination and application of the allowance allocation percentages. We believe the level of additional qualitative reserve at June 30, 2017 is warranted due to the continued uncertain economic environment which has produced losses, including those resulting from borrowers' misstatement of financial information or inaccurate certification of collateral values. Such losses are not necessarily correlated with historical loss trends or general economic conditions. Our methodology used to calculate the allowance considers historical losses; however, the historical loss rates for specific product types or credit risk grades may not fully incorporate the effects of continued weakness in the economy.

Our recorded investment in loans as of June 30, 2017, December 31, 2016 and June 30, 2016 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of our impairment methodology was as follows (in thousands):



June 30, 2017
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	120,770	$	—	$	—	$	4,514	$	—	$	—	$	125,284
Loans collectively evaluated for impairment	8,130,182		5,183,600		2,242,562		3,565,273		39,122		274,863		19,435,602
Total	$	8,250,952	$	5,183,600	$	2,242,562	$	3,569,787	$	39,122	$	274,863	$	19,560,886

December 31, 2016
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	166,669	$	—	$	159	$	3,751	$	200	$	83	$	170,862
Loans collectively evaluated for impairment	7,124,876		4,497,338		2,098,547		3,458,452		34,387		185,446		17,399,046
Total	$	7,291,545	$	4,497,338	$	2,098,706	$	3,462,203	$	34,587	$	185,529	$	17,569,908

June 30, 2016
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	164,339	$	—	$	—	$	4,210	$	—	$	—	$	168,549
Loans collectively evaluated for impairment	7,014,025		5,260,027		2,023,725		3,224,643		26,283		103,565		17,652,268
Total	$	7,178,364	$	5,260,027	$	2,023,725	$	3,228,853	$	26,283	$	103,565	$	17,820,817

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 June 30, 2017, none of our non-accrual loans were earning on a cash basis compared to $811,000 at December 31, 2016. A loan is placed back on accrual status when both principal and interest are current and it is probable that we will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.

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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 original loan agreement. In accordance with ASC 310 Receivables, we have also included all restructured and formerly restructured loans in our impaired loan totals. The following tables detail our impaired loans, by portfolio class, as of June 30, 2017 and December 31, 2016 (in thousands):



June 30, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial
Business loans	$	21,624	$	23,873	$	—	$	24,135	$	—
Energy	36,577		47,821		—		41,206		—
Construction
Market risk	—		—		—		—		—
Real estate