Edgar Filing: TEXAS CAPITAL BANCSHARES INC/TX

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09.30.2014-10Q

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, 2014



¨	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.		75,201
(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 23, 2014, 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 43,187,458

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Texas Capital Bancshares, Inc.

Form 10-Q

Quarter Ended September 30, 2014

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	31
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	49

Item 4.	Controls and Procedures	52

Part II. Other Information

Item 1.	Legal Proceedings	52

Item 1A.	Risk Factors	52

Item 6.	Exhibits	53
Signatures		54

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TEXAS CAPITAL BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS - UNAUDITED

(In thousands except share data)



	September 30, 2014			December 31, 2013

Assets
Cash and due from banks	$	102,503		$	92,484
Interest-bearing deposits	427,199			61,337
Federal funds sold and securities purchased under resale agreements	—			90
Securities, available-for-sale	43,938			63,214
Loans held for sale from discontinued operations	288			294
Loans held for investment, mortgage finance	3,774,467			2,784,265
Loans held for investment (net of unearned income)	9,686,134			8,486,309
Less: Allowance for loan losses	96,322			87,604
Loans held for investment, net	13,364,279			11,182,970
Premises and equipment, net	17,640			11,482
Accrued interest receivable and other assets	289,892			281,534
Goodwill and intangible assets, net	20,763			21,286
Total assets	$	14,266,502		$	11,714,691
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Non-interest-bearing	$	4,722,479		$	3,347,567
Interest-bearing	6,586,903			5,579,505
Interest-bearing in foreign branches	406,426			330,307
Total deposits	11,715,808			9,257,379
Accrued interest payable	1,908			749
Other liabilities	115,769			110,177
Federal funds purchased and repurchase agreements	285,678			170,604
Other borrowings	450,011			855,026
Subordinated notes	286,000			111,000
Trust preferred subordinated debentures	113,406			113,406
Total liabilities	12,968,580			10,618,341
Stockholders’ equity:
Preferred stock, $.01 par value, $1,000 liquidation value:	150,000			150,000
Authorized shares – 10,000,000
Issued shares – 6,000,000 shares issued at September 30, 2014, and December 31, 2013, respectively
Common stock, $.01 par value:
Authorized shares – 100,000,000
Issued shares – 43,179,551 and 41,036,787 at September 30, 2014, and December 31, 2013, respectively	432			410
Additional paid-in capital	558,822			448,208
Retained earnings	587,317			496,112
Treasury stock (shares at cost: 417 at September 30, 2014, and December 31, 2013)	(8		)	(8		)
Accumulated other comprehensive income, net of taxes	1,359			1,628
Total stockholders’ equity	1,297,922			1,096,350
Total liabilities and stockholders’ equity	$	14,266,502		$	11,714,691

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,
	2014			2013			2014			2013
Interest income
Interest and fees on loans	$	134,618		$	114,453		$	374,724		$	324,053
Securities	428			682			1,439			2,394
Federal funds sold	68			22			116			41
Deposits in other banks	176			60			435			172
Total interest income	135,290			115,217			376,714			326,660
Interest expense
Deposits	4,606			3,699			12,882			10,172
Federal funds purchased	82			152			292			570
Repurchase agreements	5			4			13			13
Other borrowings	68			119			321			475
Subordinated notes	4,241			1,829			11,961			5,487
Trust preferred subordinated debentures	627			638			1,862			1,905
Total interest expense	9,629			6,441			27,331			18,622
Net interest income	125,661			108,776			349,383			308,038
Provision for credit losses	6,500			5,000			15,500			14,000
Net interest income after provision for credit losses	119,161			103,776			333,883			294,038
Non-interest income
Service charges on deposit accounts	1,817			1,659			5,277			5,109
Trust fee income	1,190			1,263			3,714			3,773
Bank owned life insurance (BOLI) income	517			423			1,547			1,384
Brokered loan fees	3,821			4,078			10,002			13,600
Swap fees	464			983			2,098			3,616
Other	2,587			2,025			8,647			5,358
Total non-interest income	10,396			10,431			31,285			32,840
Non-interest expense
Salaries and employee benefits	43,189			36,012			125,141			114,744
Net occupancy expense	5,279			4,342			15,120			12,334
Marketing	4,024			3,974			11,578			12,020
Legal and professional	4,874			3,937			17,457			12,584
Communications and technology	4,928			3,696			13,213			10,165
FDIC insurance assessment	2,775			4,357			8,044			6,134
Allowance and other carrying costs for OREO	5			267			61			1,179
Other	6,841			5,424			20,390			17,283
Total non-interest expense	71,915			62,009			211,004			186,443
Income from continuing operations before income taxes	57,642			52,198			154,164			140,435
Income tax expense	20,810			18,724			55,653			49,745
Income from continuing operations	36,832			33,474			98,511			90,690
Income from discontinued operations (after-tax)	—			2			7			2
Net income	36,832			33,476			98,518			90,692
Preferred stock dividends	2,438			2,437			7,313			4,956
Net income available to common stockholders	$	34,394		$	31,039		$	91,205		$	85,736
Other comprehensive income (loss)
Change in net unrealized gain on available-for-sale securities arising during period, before-tax	$	(295	)	$	(531	)	$	(414	)	$	(2,283	)
Income tax benefit related to net unrealized gain on available-for-sale securities	(103		)	(186		)	(145		)	(799		)
Other comprehensive loss, net of tax	(192		)	(345		)	(269		)	(1,484		)
Comprehensive income	$	36,640		$	33,131		$	98,249		$	89,208
Basic earnings per common share
Income from continuing operations	$	0.80		$	0.76		$	2.13		$	2.10
Net income	$	0.80		$	0.76		$	2.13		$	2.10
Diluted earnings per common share
Income from continuing operations	$	0.78		$	0.74		$	2.09		$	2.05
Net income	$	0.78		$	0.74		$	2.09		$	2.05

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, 2012	—	$	—	40,727,996	$	407	$	450,116		$	382,455		(417	)	$	(8	)	$	3,272		$	836,242
Comprehensive income:
Net income	—	—		—	—		—			90,692			—		—			—			90,692
Change in unrealized gain on available-for-sale securities, net of taxes of $799	—	—		—	—		—			—			—		—			(1,484		)	(1,484		)
Total comprehensive income																					89,208
Tax benefit related to exercise of stock-based awards	—	—		—	—		124			—			—		—			—			124
Stock-based compensation expense recognized in earnings	—	—		—	—		2,896			—			—		—			—			2,896
Issuance of preferred stock	6,000,000	150,000		—	—		(5,013		)	—			—		—			—			144,987
Preferred stock dividend	—	—		—	—		—			(4,956		)	—		—			—			(4,956		)
Issuance of stock related to stock-based awards	—	—		207,044	2		(1,874		)	—			—		—			—			(1,872		)
Balance at September 30, 2013	6,000,000	$	150,000	40,935,040	$	409	$	446,249		$	468,191		(417	)	$	(8	)	$	1,788		$	1,066,629
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
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

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,
	2014			2013
Operating activities
Net income from continuing operations	$	98,511		$	90,690
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses	15,500			14,000
Depreciation and amortization	10,583			8,224
Amortization and accretion on securities	—			19
Bank owned life insurance (BOLI) income	(1,547		)	(1,384		)
Stock-based compensation expense	11,690			14,464
Tax benefit from stock-based award exercises	2,534			124
Excess tax expense from stock-based compensation arrangements	(7,242		)	(355		)
Gain on sale of assets	(821		)	(490		)
Changes in operating assets and liabilities:
Accrued interest receivable and other assets	(16,296		)	38,259
Accrued interest payable and other liabilities	(1,164		)	(3,097		)
Net cash provided by operating activities of continuing operations	111,748			160,454
Net cash provided by operating activities of discontinued operations	12			7
Net cash provided by operating activities	111,760			160,461
Investing activities
Maturities and calls of available-for-sale securities	11,150			15,090
Principal payments received on available-for-sale securities	7,712			14,988
Originations of mortgage finance loans	(40,244,845		)	(39,620,728		)
Proceeds from pay-offs of mortgage finance loans	39,254,643			40,533,915
Net increase in loans held for investment, excluding mortgage finance loans	(1,206,606		)	(1,270,123		)
Purchase of premises and equipment, net	(9,110		)	(3,828		)
Proceeds from sale of foreclosed assets	5,823			4,026
Cash paid for acquisition	—			(2,445		)
Net cash used in investing activities of continuing operations	(2,181,233		)	(329,105		)
Financing activities
Net increase in deposits	2,458,429			1,516,277
Net expense from issuance of stock related to stock-based awards	(2,076		)	(1,872		)
Net proceeds from issuance of common stock	106,548			—
Net proceeds from issuance of preferred stock	—			144,987
Preferred dividends paid	(7,313		)	(4,956		)
Net decrease in other borrowings	(397,462		)	(1,394,052		)
Excess tax benefits from stock-based compensation arrangements	7,242			355
Net increase (decrease) in Federal funds purchased	107,521			(103,385		)
Net proceeds from issuance of subordinated notes	172,375			—
Net cash provided by financing activities of continuing operations	2,445,264			157,354
Net increase (decrease) in cash and cash equivalents	375,791			(11,290		)
Cash and cash equivalents at beginning of period	153,911			206,348
Cash and cash equivalents at end of period	$	529,702		$	195,058
Supplemental disclosures of cash flow information:
Cash paid during the period for interest	$	26,172		$	18,529
Cash paid during the period for income taxes	51,722			55,246
Transfers from loans/leases to OREO and other repossessed assets	851			980

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 or 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 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, 2013, included in our Annual Report on Form 10-K filed with the SEC on February 20, 2014 (the “2013 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.

Correction of an Error in the Financial Statements

We determined during the fourth quarter of 2013 that purchases and sales of mortgage finance loan interests that had been reported on our consolidated statements of cash flows as cash flows from operating activities should have been reported as investing activities because the related asset balances should have been reported as held for investment rather than held for sale on our consolidated balance sheets.

We have corrected the classification of these assets on the consolidated balance sheets to reflect them as held for investment. We have corrected the previously presented cash flows for these loans and in doing so the consolidated statements of cash flows for the nine months ended September 30, 2013 were adjusted to decrease net cash flows from operating activities by $913.2 million, with a corresponding increase in net cash flows from investing activities. The change does not impact our reported earnings as we do not believe any reserve for loan losses relating to the mortgage finance 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 last eleven years. This reclassification does not change total loans or total assets on our consolidated balance sheets. We have evaluated the effect of the incorrect presentation, both qualitatively and quantitatively, and concluded that it did not materially misstate our previously issued financial statements.

Cash and Cash Equivalents

Cash equivalents include amounts due from banks, interest-bearing deposits and Federal funds sold.

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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.

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 (loss), 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, 2014 and December 31, 2013.

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 investment includes legal ownership interests in mortgage loans that we purchase through our mortgage warehouse lending 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 and that of the originator are delivered by us to the investor selected by the originator and approved by us. We typically purchase up to a 99% ownership interest in each mortgage with the originator owning the remaining percentage. These mortgage ownership interests 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 Accounting Standards Codification 860, Transfers and Servicing of Financial Assets (“ASC 860”), the ownership interests do not qualify as

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participating interests. Under ASC 860, the ownership interests are deemed to be loans to the originators and payments we receive from investors are deemed to be payments made by or on behalf of the originator to repay the loan deemed made to the originator. Because we have an actual, legal ownership interest in the underlying residential mortgage loan, these interests are not extensions of credit to the originators that are secured by the mortgage loans as collateral.

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 mortgage loans and hold them beyond the expected 10-20 days. Mortgage loans acquired under these conditions could require future allocations of the allowance for loan losses or be subject to charge off in the event the loans become impaired. Mortgage loan interests purchased and disposed of as expected receive no allocation of the allowance for loan losses due to the minimal loss experience with these assets.

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 collectability 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.

Other Real Estate Owned

Other real estate owned (“OREO”), which is included in other assets on the consolidated 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, and 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. Internal use software costs are included in other assets in the consolidated balance sheets.

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.

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.

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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 consolidated statements of income and other comprehensive income 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. Other comprehensive income (loss), net of tax, for the nine months ended September 30, 2014 and 2013 is reported in the accompanying consolidated statements of stockholders’ equity and consolidated statements of income and other 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 awards. Diluted earnings per common share includes the dilutive effect of stock options and non-vested stock awards 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,
	2014		2013		2014		2013
Numerator:
Net income from continuing operations	$	36,832	$	33,474	$	98,511	$	90,690
Preferred stock dividends	2,438		2,437		7,313		4,956
Net income from continuing operations available to common stockholders	34,394		31,037		91,198		85,734
Income from discontinued operations	—		2		7		2
Net income	$	34,394	$	31,039	$	91,205	$	85,736
Denominator:
Denominator for basic earnings per share— weighted average shares	43,143,580		40,901,867		42,842,143		40,824,223
Effect of employee stock-based awards(1)	284,859		375,773		333,690		415,867
Effect of warrants to purchase common stock	421,399		514,034		464,305		502,294
Denominator for dilutive earnings per share—adjusted weighted average shares and assumed conversions	43,849,838		41,791,674		43,640,138		41,742,384
Basic earnings per common share from continuing operations	$	0.80	$	0.76	$	2.13	$	2.10
Basic earnings per common share	$	0.80	$	0.76	$	2.13	$	2.10
Diluted earnings per share from continuing operations	$	0.78	$	0.74	$	2.09	$	2.05
Diluted earnings per common share	$	0.78	$	0.74	$	2.09	$	2.05


(1)	Stock options, SARs and RSUs outstanding of 50,500 at September 30, 2014 and 98,000 at September 30, 2013 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, 2014, our net unrealized gain on the available-for-sale securities portfolio was $2.1 million compared to $2.5 million at December 31, 2013. As a percent of outstanding balances, the unrealized gain was 5.00% and 4.13% at September 30, 2014, and December 31, 2013, respectively. The increase in the percent of outstanding balances at September 30, 2014 related to slight change in market value and the declining outstanding balance.

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



	September 30, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-Sale Securities:
Residential mortgage-backed securities	$	31,068	$	2,264	$	—		$	33,332
Municipals	3,257		11		—			3,268
Equity securities(1)	7,522		7		(191		)	7,338
	$	41,847	$	2,282	$	(191	)	$	43,938

	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-Sale Securities:
Residential mortgage-backed securities	$	38,786	$	2,676	$	—		$	41,462
Municipals	14,401		104		—			14,505
Equity securities(1)	7,522		—		(275		)	7,247
	$	60,709	$	2,780	$	(275	)	$	63,214


(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, 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	$	3		$	10,348		$	6,048		$	14,669		$	31,068
Estimated fair value	3			10,958			6,738			15,633			33,332
Weighted average yield(3)	6.50		%	4.80		%	5.53		%	2.36		%	3.79		%
Municipals:(2)
Amortized cost	1,669			1,588			—			—			3,257
Estimated fair value	1,674			1,594			—			—			3,268
Weighted average yield(3)	5.78		%	5.79		%	—			—			5.79		%
Equity securities:(4)
Amortized cost	7,522			—			—			—			7,522
Estimated fair value	7,338			—			—			—			7,338
Total available-for-sale securities:
Amortized cost													$	41,847
Estimated fair value													$	43,938

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	December 31, 2013
	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	$	238		$	14,720		$	7,718		$	16,110		$	38,786
Estimated fair value	252			15,641			8,456			17,113			41,462
Weighted average yield(3)	4.32		%	4.78		%	5.56		%	2.40		%	3.94		%
Municipals:(2)
Amortized cost	7,749			6,652			—			—			14,401
Estimated fair value	7,818			6,687			—			—			14,505
Weighted average yield(3)	5.76		%	5.71		%	—			—			5.73		%
Equity securities:(4)
Amortized cost	7,522			—			—			—			7,522
Estimated fair value	7,247			—			—			—			7,247
Total available-for-sale securities:
Amortized cost													$	60,709
Estimated fair value													$	63,214


(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 $34.6 million were pledged to secure certain borrowings and deposits at September 30, 2014. Of the pledged securities at September 30, 2014, approximately $11.2 million were pledged for certain deposits, and approximately $23.4 million were pledged for repurchase agreements.

The following table discloses, as of September 30, 2014 and December 31, 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):



September 30, 2014	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Equity securities	$	—	$	—		$	6,309	$	(191	)	$	6,309	$	(191	)

December 31, 2013	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Equity securities	$	7,247	$	(275	)	$	—	$	—		$	7,247	$	(275	)

At September 30, 2014, there was 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. We have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on this security.

Unrealized gains or losses on our available-for-sale securities (after applicable income tax expense or benefit) are included in accumulated other comprehensive income (loss), net. Comprehensive income for the nine months ended September 30, 2014 and 2013 included net after-tax losses of $269,000 and $1.5 million, respectively, due to changes in the net unrealized gains/losses on securities available-for-sale.

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(4) LOANS AND ALLOWANCE FOR LOAN LOSSES

At September 30, 2014 and December 31, 2013, loans were as follows (in thousands):



	September 30, 2014			December 31, 2013
Commercial	$	5,621,336		$	5,020,565
Mortgage finance	3,774,467			2,784,265
Construction	1,640,596			1,262,905
Real estate	2,362,230			2,146,228
Consumer	16,502			15,350
Leases	101,327			93,160
Gross loans held for investment	13,516,458			11,322,473
Deferred income (net of direct origination costs)	(55,857		)	(51,899		)
Allowance for loan losses	(96,322		)	(87,604		)
Total	$	13,364,279		$	11,182,970

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.

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. September 30, 2014 and December 31, 2013 balances are stated net of $290.4 million and $33.1 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. However, 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 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.

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 September 30, 2014 and December 31, 2013, we had a blanket floating lien based on certain real estate loans used as collateral for Federal Home Loan Bank (“FHLB”) borrowings.

Portfolio Geographic Concentration

As of September 30, 2014, a substantial majority of our loans held for investment, excluding our mortgage finance loans and other national lines of business, were to businesses and individuals 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. 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 reflects 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. Examples of such risks that support the Bank's maintaining an unallocated reserve include 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. The allowance is considered 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 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. The review of the reserve adequacy 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, 2014 and December 31, 2013 (in thousands):



September 30, 2014
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Grade:
Pass	$	5,479,240	$	3,774,467	$	1,640,596	$	2,332,791	$	16,384	$	96,269	$	13,339,747
Special mention	68,215		—		—		7,490		13		777		76,495
Substandard-accruing	48,875		—		—		9,232		105		4,271		62,483
Non-accrual	25,006		—		—		12,717		—		10		37,733
Total loans held for investment	$	5,621,336	$	3,774,467	$	1,640,596	$	2,362,230	$	16,502	$	101,327	$	13,516,458
December 31, 2013
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Grade:
Pass	$	4,908,944	$	2,784,265	$	1,261,995	$	2,099,450	$	15,251	$	89,317	$	11,159,222
Special mention	24,132		—		102		6,338		—		51		30,623
Substandard-accruing	74,593		—		103		21,770		45		3,742		100,253
Non-accrual	12,896		—		705		18,670		54		50		32,375
Total loans held for investment	$	5,020,565	$	2,784,265	$	1,262,905	$	2,146,228	$	15,350	$	93,160	$	11,322,473

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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, 2014 and September 30, 2013. 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, 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
September 30, 2013
(in thousands)	Commercial		Mortgage Finance		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

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Our recorded investment in loans as of September 30, 2014, December 31, 2013 and September 30, 2013 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, 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		2,344,326		16,502		101,317		13,471,435
Total	$	5,621,336	$	3,774,467	$	1,640,596	$	2,362,230	$	16,502	$	101,327	$	13,516,458
December 31, 2013
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	15,139	$	—	$	705	$	24,028	$	54	$	50	$	39,976
Loans collectively evaluated for impairment	5,005,426		2,784,265		1,262,200		2,122,200		15,296		93,110		11,282,497
Total	$	5,020,565	$	2,784,265	$	1,262,905	$	2,146,228	$	15,350	$	93,160	$	11,322,473
September 30, 2013
	Commercial		Mortgage Finance		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		2,262,085		1,125,908		2,063,313		19,549		85,879		10,315,546
Total	$	4,782,234	$	2,262,085	$	1,125,908	$	2,087,058	$	19,619	$	85,936	$	10,362,840

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, 2014 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.

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, 2014, $310,000 of our non-accrual loans were earning on a cash basis, compared to none at December 31, 2013. 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. The table below summarizes our non-accrual loans by type and purpose as of September 30, 2014 and December 31, 2013 (in thousands):

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