Independent Bank Group, Inc.
Independent Bank Group, Inc. (Form: 10-Q, Received: 10/27/2016 16:48:43)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549    

FORM 10-Q
(Mark One)
ý
Quarterly Report Pursuant to Section   13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended September 30, 2016 .
or
¨
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 001-35854

Independent Bank Group, Inc.
(Exact name of registrant as specified in its charter)    
Texas
   
13-4219346
(State or other jurisdiction of incorporation or organization)
   
(I.R.S. Employer Identification No.)
   
   
   
1600 Redbud Boulevard, Suite 400
McKinney, Texas
   
75069-3257
(Address of principal executive offices)
   
(Zip Code)
(972) 562-9004
(Registrant’s telephone number, including area code)
Not applicable
(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 Securities Exchange Act of 1934 during the preceding 12 months (or such shorter periods 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 (§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 or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Check One:
   
Large accelerated filer
   
¨
      
Accelerated filer
   
ý
   
   
   
   
Non-accelerated filer
   
¨
      
Smaller reporting company
   
¨
Indicate by a 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
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
Common Stock, Par Value $0.01 Per Share – 18,469,562 shares as of October 26, 2016.





INDEPENDENT BANK GROUP, INC. AND SUBSIDIARIES
Form 10-Q
September 30, 2016
   
PART I.
 
 
   
   
   
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   
   
 
 
Item 2.
 
   
   
   
 
Item 3.
 
   
   
   
 
Item 4.
 
   
   
   
 
PART II.
 
 
   
   
   
 
Item 1.
   
   
   
   
 
Item 1A.
   
   
   
   
 
Item 2
   
   
   
   
 
Item 3.
   
   
   
   
 
Item 4.
   
   
   
 
 
Item 5.
   
   
   
   
 
Item 6.
   
   
   
   
 
   
 
 
   


***






Independent Bank Group, Inc. and Subsidiaries

Consolidated Balance Sheets
September 30, 2016 (unaudited) and December 31, 2015
(Dollars in thousands, except share information)
   
 
September 30,
 
December 31,
Assets
 
2016
 
2015
   
 
   
 
   
Cash and due from banks
 
$
150,968

 
$
129,096

Interest-bearing deposits in other banks
 
438,632

 
164,183

Cash and cash equivalents
 
589,600

 
293,279

Certificates of deposit held in other banks
 

 
61,746

Securities available for sale (amortized cost of $263,236 and $270,711, respectively)
 
267,860

 
273,463

Loans held for sale
 
7,097

 
12,299

Loans, net of allowance for loan losses of $29,575 and $27,043, respectively
 
4,329,217

 
3,960,809

Premises and equipment, net
 
89,928

 
93,015

Other real estate owned
 
2,083

 
2,168

Federal Home Loan Bank (FHLB) of Dallas stock and other restricted stock
 
26,452

 
14,256

Bank-owned life insurance (BOLI)
 
56,798

 
40,861

Deferred tax asset
 
5,349

 
5,892

Goodwill
 
258,319

 
258,643

Core deposit intangible, net
 
14,669

 
16,357

Other assets
 
19,823

 
22,212

Total assets
 
$
5,667,195

 
$
5,055,000

 
 
 
 
 
Liabilities, Temporary Equity and Stockholders’ Equity
 
   
 
   
Deposits:
 
   
 
   
Noninterest-bearing
 
$
1,143,479

 
$
1,071,656

Interest-bearing
 
3,273,014

 
2,956,623

Total deposits
 
4,416,493

 
4,028,279

 
 
 
 
 
FHLB advances
 
470,765

 
288,325

Repurchase agreements
 

 
12,160

Other borrowings
 
107,159

 
68,295

Other borrowings, related parties
 
50

 
2,503

Junior subordinated debentures
 
18,147

 
18,147

Other liabilities
 
11,328

 
9,982

Total liabilities
 
5,023,942

 
4,427,691

Commitments and contingencies
 


 


 
 
 
 
 
Temporary equity:   Series A preferred stock (0 and 23,938.35 shares issued and outstanding, respectively)
 

 
23,938

Stockholders’ equity:
 
   
 
   
Common stock (18,488,628 and 18,399,194 shares outstanding, respectively)
 
185

 
184

Additional paid-in capital
 
534,446

 
530,107

Retained earnings
 
105,023

 
70,698

Accumulated other comprehensive income
 
3,599

 
2,382

Total stockholders’ equity
 
643,253

 
603,371

Total liabilities, temporary equity and stockholders’ equity
 
$
5,667,195

 
$
5,055,000

See Notes to Consolidated Financial Statements

1





Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Income
Three and Nine Months Ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands, except per share information)
   
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
   
 
2016
 
2015
 
2016
 
2015
Interest income:
 
 
 
 
 
   
 
   
Interest and fees on loans
 
$
51,194

 
$
42,145

 
$
151,522

 
$
123,350

Interest on taxable securities
 
573

 
393

 
2,067

 
1,553

Interest on nontaxable securities
 
394

 
461

 
1,289

 
1,324

Interest on interest-bearing deposits and other
 
579

 
131

 
1,267

 
386

Total interest income
 
52,740

 
43,130

 
156,145

 
126,613

Interest expense:
 
 
 
 
 
   
 
 
Interest on deposits
 
4,049

 
3,067

 
11,623

 
8,794

Interest on FHLB advances
 
1,063

 
773

 
3,062

 
2,243

Interest on repurchase agreements and other borrowings
 
1,733

 
1,064

 
3,723

 
3,229

Interest on junior subordinated debentures
 
158

 
137

 
457

 
400

Total interest expense
 
7,003

 
5,041

 
18,865

 
14,666

Net interest income
 
45,737

 
38,089

 
137,280

 
111,947

Provision for loan losses
 
2,123

 
3,932

 
7,243

 
7,261

Net interest income after provision for loan losses
 
43,614

 
34,157

 
130,037

 
104,686

Noninterest income:
 
 
 
 
 
   
 
 
Service charges on deposit accounts
 
1,840

 
1,777

 
5,287

 
5,041

Mortgage fee income
 
1,922

 
1,353

 
5,319

 
4,082

Gain on sale of loans
 

 
116

 

 
116

Loss on sale of branch
 
(43
)
 

 
(43
)
 

Gain on sale of other real estate
 
4

 
41

 
57

 
220

Gain on sale of securities available for sale
 

 

 
4

 
90

Gain (loss) on sale of premises and equipment
 
(9
)
 
(374
)
 
32

 
(374
)
Increase in cash surrender value of BOLI
 
402

 
268

 
937

 
806

Other
 
816

 
618

 
2,738

 
1,893

Total noninterest income
 
4,932

 
3,799

 
14,331

 
11,874

Noninterest expense:
 
 
 
 
 
   
 
 
Salaries and employee benefits
 
15,303

 
14,918

 
51,644

 
43,992

Occupancy
 
4,038

 
4,117

 
12,119

 
12,054

Data processing
 
1,190

 
786

 
3,575

 
2,140

FDIC assessment
 
1,123

 
541

 
2,718

 
1,553

Advertising and public relations
 
229

 
313

 
775

 
912

Communications
 
563

 
550

 
1,648

 
1,643

Net other real estate owned expenses (including taxes)
 
145

 
88

 
180

 
184

Other real estate impairment
 
51

 
10

 
106

 
35

Core deposit intangible amortization
 
492

 
363

 
1,472

 
1,102

Professional fees
 
717

 
841

 
2,354

 
2,008

Acquisition expense, including legal
 
3

 
293

 
732

 
793

Other
 
3,033

 
3,010

 
9,106

 
8,255

Total noninterest expense
 
26,887

 
25,830

 
86,429

 
74,671

 
 
 
 
 
 
 
 
 
Income before taxes
 
21,659

 
12,126

 
57,939

 
41,889

Income tax expense
 
7,155

 
3,924

 
19,174

 
13,664

Net income
 
$
14,504

 
$
8,202

 
$
38,765

 
$
28,225

Basic earnings per share
 
$
0.78

 
$
0.48

 
$
2.10

 
$
1.64

Diluted earnings per share
 
$
0.78

 
$
0.47

 
$
2.09

 
$
1.63


See Notes to Consolidated Financial Statements

2





Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income
Three and Nine Months Ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands)
   
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
   
 
2016
 
2015
 
2016
 
2015
Net income
 
$
14,504

 
$
8,202

 
$
38,765

 
$
28,225

Other comprehensive income (loss) before tax:
 
   
 
 
 
   
 
 
Change in net unrealized gains (losses) on available for sale securities during the year
 
(736
)
 
1,414

 
1,876

 
798

Reclassification adjustment for gain on sale of securities available for sale included in net income
 

 

 
(4
)
 
(90
)
Other comprehensive income (loss) before tax
 
(736
)
 
1,414

 
1,872

 
708

Income tax expense (benefit)
 
(258
)
 
496

 
655

 
248

Other comprehensive income (loss), net of tax
 
(478
)
 
918

 
1,217

 
460

Comprehensive income
 
$
14,026

 
$
9,120

 
$
39,982

 
$
28,685


See Notes to Consolidated Financial Statements
   

3





Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity
Nine Months Ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands, except for par value, share and per share information)
   
   
Series A Preferred Stock
$.01 Par Value
10 million shares authorized
 
Common Stock
$.01 Par Value
100 million shares authorized
 
Additional
Paid in Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Total
   
 
Shares
 
Amount
 
Balance, December 31, 2015
$

 
18,399,194

 
$
184

 
$
530,107

 
$
70,698

 
$
2,382

 
$
603,371

Net income

 

 

 

 
38,765

 

 
38,765

Other comprehensive income, net of tax

 

 

 

 

 
1,217

 
1,217

Restricted stock forfeited

 
(6,036
)
 

 

 

 

 

Restricted stock granted

 
95,470

 
1

 
(1
)
 

 

 

Stock based compensation expense

 

 

 
4,533

 

 

 
4,533

Income tax deficiency on restricted stock vested

 

 

 
(193
)
 

 

 
(193
)
Preferred stock dividends

 

 

 

 
(8
)
 

 
(8
)
Cash dividends ($0.24 per share)

 

 

 

 
(4,432
)
 

 
(4,432
)
Balance, September 30, 2016
$

 
18,488,628

 
$
185

 
$
534,446

 
$
105,023

 
$
3,599

 
$
643,253

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2014
$
23,938

 
17,032,669

 
$
170

 
$
476,609

 
$
37,731

 
$
2,403

 
$
540,851

Net income

 

 

 

 
28,225

 

 
28,225

Other comprehensive income, net of tax

 

 

 

 

 
460

 
460

Offering costs related to acquired bank

 

 

 
(144
)
 

 

 
(144
)
Restricted stock forfeited

 
(11,399
)
 

 

 

 

 

Restricted stock granted

 
90,124

 
1

 
(1
)
 

 

 

Income tax deficiency on restricted stock vested

 

 

 
(63
)
 

 

 
(63
)
Stock based compensation expense

 

 

 
3,214

 

 

 
3,214

Preferred stock dividends

 

 

 

 
(180
)
 

 
(180
)
Cash dividends ($0.24 per share)

 

 

 

 
(4,106
)
 

 
(4,106
)
Balance, September 30, 2015
$
23,938

 
17,111,394

 
$
171

 
$
479,615

 
$
61,670

 
$
2,863

 
$
568,257

   
See Notes to Consolidated Financial Statements 

4





Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands)  
   
 
Nine Months Ended September 30,
   
 
2016
 
2015
Cash flows from operating activities:
 
   
 
   
Net income
 
$
38,765

 
$
28,225

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation expense
 
5,027

 
4,646

Accretion of income recognized on acquired loans
 
(4,218
)
 
(1,587
)
Amortization of core deposit intangibles
 
1,472

 
1,102

Amortization of premium on securities, net
 
1,528

 
1,160

Amortization of discount and origination costs on other borrowings
 
151

 
110

Stock based compensation expense
 
4,533

 
3,214

FHLB stock dividends
 
(176
)
 
(32
)
Gain on sale of securities available for sale
 
(4
)
 
(90
)
(Gain) loss on sale of premises and equipment
 
(32
)
 
374

Gain on sale of loans
 

 
(116
)
Loss on sale of branch
 
43

 

Gain recognized on other real estate transactions
 
(57
)
 
(220
)
Impairment of other real estate
 
106

 
35

Deferred tax benefit
 
(151
)
 
(2,992
)
Provision for loan losses
 
7,243

 
7,261

Increase in cash surrender value of life insurance
 
(937
)
 
(806
)
Loans originated for sale
 
(206,567
)
 
(166,506
)
Proceeds from sale of loans
 
211,769

 
164,741

Net change in other assets
 
1,161

 
1,708

Net change in other liabilities
 
1,163

 
(4,678
)
Net cash provided by operating activities
 
60,819

 
35,549

Cash flows from investing activities:
 
   
 
   
Proceeds from maturities, calls and pay downs of securities available for sale
 
1,107,530

 
528,863

Proceeds from sale of securities available for sale
 
5,399

 
12,128

Purchases of securities available for sale
 
(1,106,978
)
 
(522,599
)
Proceeds from maturities of certificates held in other banks
 
61,746

 

Proceeds from sale of loans
 

 
8,765

Purchase of bank owned life insurance contracts
 
(15,000
)
 

Net purchases of FHLB stock
 
(12,020
)
 
(834
)
Net loans originated
 
(372,524
)
 
(335,421
)
Additions to premises and equipment
 
(4,680
)
 
(11,500
)
Proceeds from sale of premises and equipment
 
579

 
4,228

Proceeds from sale of other real estate owned
 
1,860

 
2,324

Capitalized additions to other real estate owned
 

 
(10
)
Cash paid in connection with branch sale
 
(107
)
 

Net cash transferred in branch sale
 
(2,399
)
 

Net cash used in investing activities
 
(336,594
)
 
(314,056
)
Cash flows from financing activities:
 
   
 
   
Net increase in demand deposits, NOW and savings accounts
 
336,624

 
191,392

Net increase in time deposits
 
35,530

 
89,038

Proceeds from FHLB advances
 
575,000

 
230,000

Repayments of FHLB advances
 
(392,560
)
 
(196,059
)
Net change in repurchase agreements
 
8,528

 

Repayments of other borrowings
 
(5,798
)
 
(1,591
)
Proceeds from other borrowings
 
43,150

 

Redemption of preferred stock
 
(23,938
)
 

Offering costs paid in connection with acquired banks
 

 
(144
)
Dividends paid
 
(4,440
)
 
(4,226
)
Net cash provided by financing activities
 
572,096

 
308,410

Net change in cash and cash equivalents
 
296,321

 
29,903

Cash and cash equivalents at beginning of year
 
293,279

 
324,047

Cash and cash equivalents at end of period
 
$
589,600

 
$
353,950


See Notes to Consolidated Financial Statements 

5





Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)

Note 1. Summary of Significant Accounting Policies
Nature of Operations: Independent Bank Group, Inc. (IBG) through its subsidiary, Independent Bank, a Texas state banking corporation (Bank) (collectively known as the Company), provides a full range of banking services to individual and corporate customers in the North Texas, Central Texas and Houston areas through its various branch locations in those areas. The Company is engaged in traditional community banking activities, which include commercial and retail lending, deposit gathering, investment and liquidity management activities. The Company’s primary deposit products are demand deposits, money market accounts and certificates of deposit, and its primary lending products are commercial business and real estate, real estate mortgage and consumer loans.
Basis of Presentation: The accompanying consolidated financial statements include the accounts of IBG, its wholly-owned subsidiaries, the Bank and IBG Adriatica Holdings, Inc. (Adriatica) and the Bank’s wholly-owned subsidiaries, IBG Real Estate Holdings, Inc., IBG Aircraft Company III, Preston Grand, Inc, and McKinney Avenue Holdings, Inc. and its wholly owned subsidiary, McKinney Avenue SPE 1, Inc. McKinney Avenue Holdings, Inc. and its subsidiary were formed during the first quarter 2016 for the purpose of possible future asset holdings. Adriatica became inactive in 2014. All material intercompany transactions and balances have been eliminated in consolidation. In addition, the Company wholly-owns IB Trust I (Trust I), IB Trust II (Trust II), IB Trust III (Trust III), IB Centex Trust I (Centex Trust I) and Community Group Statutory Trust I (CGI Trust I). The Trusts were formed to issue trust preferred securities and do not meet the criteria for consolidation.
The consolidated interim financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented. All such adjustments were of a normal and recurring nature. These financial statements should be read in conjunction with the financial statements and the notes thereto in the Company's Annual Report of Form10-K for the year ended December 31, 2015. The consolidated statement of condition at December 31, 2015 had been derived from the audited financial statements as of that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.
Segment Reporting: The Company has one reportable segment. The Company’s chief operating decision-maker uses consolidated results to make operating and strategic decisions.
Reclassifications: Certain prior period financial statement amounts have been reclassified to conform to current period presentation. The reclassifications have no effect on net income or stockholders' equity as previously reported.

Redemption of Small Business Lending Fund Series A Preferred Stock: On January 14, 2016, the Company redeemed all outstanding shares of its Senior Non-Cumulative Perpetual Small Business Lending Fund Series A Preferred Stock held by the Treasury and related accrued dividends.

Subsequent events: Companies are required to evaluate events and transactions that occur after the balance sheet date but before the date the financial statements are issued. They must recognize in the financial statements the effect of all events or transactions that provide additional evidence of conditions that existed at the balance sheet date, including the estimates inherent in the financial statement preparation process. Entities shall not recognize the impact of events or transactions that provide evidence about conditions that did not exist at the balance sheet date but arose after that date. The Company has evaluated subsequent events through the date of filing these financial statements with the Securities and Exchange Commission (SEC) and noted no subsequent events requiring financial statement recognition or disclosure, except as disclosed in Note 12.
Earnings per share: Basic earnings per common share are net income available to common shareholders divided by the weighted average number of common shares outstanding during the period. The unvested share-based payment awards that contain rights to non forfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock warrants. The participating nonvested common stock was not included in dilutive shares as it was anti-dilutive. Proceeds from the assumed exercise of dilutive stock warrants are assumed to be used to repurchase common stock at the average market price.

6





The following table presents a reconciliation of net income available to common shareholders and the number of shares used in the calculation of basic and diluted earnings per common share.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
   
2016
 
2015
 
2016
 
2015
Basic earnings per share:
   
 
   
 
 
 
 
Net income
$
14,504

 
$
8,202

 
$
38,765

 
$
28,225

Less: Preferred stock dividends

 
60

 
8

 
180

Net income after preferred stock dividends
14,504

 
8,142

 
38,757

 
28,045

Less:
 
 
 
 
 
 
 
Undistributed earnings allocated to participating securities
204

 
131

 
593

 
492

Dividends paid on participating securities
23

 
27

 
76

 
84

Net income available to common shareholders
$
14,277

 
$
7,984

 
$
38,088

 
$
27,469

Weighted-average basic shares outstanding
18,189,163

 
16,778,405

 
18,145,604

 
16,753,526

Basic earnings per share
$
0.78

 
$
0.48

 
$
2.10

 
$
1.64

Diluted earnings per share:
   
 
   
 
 
 
 
Net income available to common shareholders
$
14,277

 
$
7,984

 
$
38,088

 
$
27,469

Total weighted-average basic shares outstanding
18,189,163

 
16,778,405

 
18,145,604

 
16,753,526

Add dilutive stock warrants
90,333

 
89,191

 
78,659

 
85,161

Total weighted-average diluted shares outstanding
18,279,496

 
16,867,596

 
18,224,263

 
16,838,687

Diluted earnings per share
$
0.78

 
$
0.47

 
$
2.09

 
$
1.63

Anti-dilutive participating securities
106,355

 
50,770

 
69,460

 
55,802

 

7





Note 2. Statement of Cash Flows
As allowed by the accounting standards, the Company has chosen to report on a net basis its cash receipts and cash payments for time deposits accepted and repayments of those deposits, and loans made to customers and principal collections on those loans. The Company uses the indirect method to present cash flows from operating activities. Other supplemental cash flow information is presented below:    
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
Cash transactions:
 
 
 
 
Interest expense paid
 
$
19,381

 
$
15,794

Income taxes paid
 
$
19,560

 
$
16,600

Noncash transactions:
 
 
 
 
Accrued preferred stock dividends
 
$

 
$
60

Transfers of loans to other real estate owned
 
$
1,824

 
$
221

Loans to facilitate the sale of other real estate owned
 
$

 
$
159

Securities purchased, not yet settled
 
$

 
$
12,880

Excess tax deficiency on restricted stock vested
 
$
(193
)
 
$
(63
)
Transfer of repurchase agreements to deposits
 
$
20,688

 
$
4,012

  
Supplemental schedule of noncash investing activities from branch sale is as follows:
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
Noncash assets transferred:
 
 
 
 
Loans
 
$
2

 
$

Premises and equipment
 
2,193

 

Total assets
 
$
2,195

 
$

Noncash liabilities transferred:
 
 
 
 
Deposits
 
$
4,628

 
$

Other liabilities
 
30

 

Total liabilities
 
$
4,658

 
$

Cash and cash equivalents transferred in branch sale
 
$
208

 
$

Deposit premium received
 
$
64

 
$

Cash paid to buyer, net of deposit premium
 
$
2,191

 
$


The supplemental schedule of noncash investing activities from Company acquisition activity includes the following measurement-period adjustments made during the period:
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
Assets acquired:
 
 
 
 
Loans
 
$
735

 
$

Goodwill
 
(324
)
 
361

Other real estate owned
 

 
(373
)
Core deposit intangibles
 
(216
)
 

Deferred tax asset
 
(175
)
 
193

Total assets
 
$
20

 
$
181

Liabilities assumed:
 
 
 
 
Other liabilities
 
20

 
181

Total liabilities
 
$
20

 
$
181


8





Note 3. Securities Available for Sale
Securities available for sale have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their approximate fair values at September 30, 2016 and December 31, 2015, are as follows:    
   
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Securities Available for Sale
 
   
 
   
 
   
 
   
September 30, 2016
 
   
 
   
 
   
 
   
Government agency securities
 
$
107,660

 
$
495

 
$
(78
)
 
$
108,077

Obligations of state and municipal subdivisions
 
82,422

 
2,424

 
(163
)
 
84,683

Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
73,154

 
1,951

 
(5
)
 
75,100

   
 
$
263,236

 
$
4,870

 
$
(246
)
 
$
267,860

December 31, 2015
 
   
 
   
 
   
 
   
U.S. treasuries
 
$
999

 
$
3

 
$

 
$
1,002

Government agency securities
 
135,630

 
237

 
(567
)
 
135,300

Obligations of state and municipal subdivisions
 
83,442

 
2,222

 
(248
)
 
85,416

Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
50,640

 
1,202

 
(97
)
 
51,745

   
 
$
270,711

 
$
3,664

 
$
(912
)
 
$
273,463

Securities with a carrying amount of approximately $ 172,232 and $ 195,479 at September 30, 2016 and December 31, 2015, respectively, were pledged to secure public fund deposits and repurchase agreements.
Proceeds from sale of securities available for sale and gross gains and gross losses for the three months and nine months ended September 30, 2016 and 2015 were as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Proceeds from sale
 
$

 
$

 
$
5,399

 
$
12,128

Gross gains
 

 

 
4

 
90

Gross losses
 

 

 

 

The amortized cost and estimated fair value of securities available for sale at September 30, 2016 , by contractual maturity, are shown below. Maturities of pass-through certificates will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.   
 
 
September 30, 2016
 
 
Securities Available for Sale
 
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
27,928

 
$
27,945

Due from one year to five years
 
88,464

 
88,997

Due from five to ten years
 
29,812

 
30,442

Thereafter
 
43,878

 
45,376

 
 
190,082

 
192,760

Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
73,154

 
75,100

 
 
$
263,236

 
$
267,860


9





The number of securities, unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of September 30, 2016 and December 31, 2015, are summarized as follows:   
   
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
Description of Securities
 
Number of Securities
 
Estimated
Fair Value
 
Unrealized
Losses
 
Number of Securities
 
Estimated
Fair Value
 
Unrealized
Losses
 
Estimated
Fair Value
 
Unrealized
Losses
Securities Available for Sale
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
September 30, 2016
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
Government agency securities
 
9
 
$
18,955

 
$
(77
)
 
1
 
$
999

 
$
(1
)
 
$
19,954

 
$
(78
)
Obligations of state and municipal subdivisions
 
42
 
22,205

 
(155
)
 
4
 
1,560

 
(8
)
 
23,765

 
(163
)
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
2
 
4,295

 
(5
)
 
 

 

 
4,295

 
(5
)
   
 
53
 
$
45,455

 
$
(237
)
 
5
 
$
2,559

 
$
(9
)
 
$
48,014

 
$
(246
)
December 31, 2015
 
 
 
   
 
   
 
 
 
   
 
   
 
   
 
   
Government agency securities
 
25
 
$
84,798

 
$
(531
)
 
4
 
$
4,964

 
$
(36
)
 
$
89,762

 
$
(567
)
Obligations of state and municipal subdivisions
 
32
 
16,202

 
(88
)
 
19
 
8,662

 
(160
)
 
24,864

 
(248
)
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC
 
6
 
10,765

 
(97
)
 
 

 

 
10,765

 
(97
)
   
 
63
 
$
111,765

 
$
(716
)
 
23
 
$
13,626

 
$
(196
)
 
$
125,391

 
$
(912
)
Unrealized losses are generally due to changes in interest rates. The Company has the intent to hold these securities until maturity or a forecasted recovery, and it is more likely than not that the Company will not have to sell the securities before the recovery of their cost basis. As such, the losses are deemed to be temporary.   

10





Note 4. Loans, Net and Allowance for Loan Losses
Loans, net, at September 30, 2016 and December 31, 2015, consisted of the following:
   
 
 
September 30,
 
December 31,
   
 
2016
 
2015
Commercial
 
$
618,257

 
$
731,818

Real estate:
 
   
 
   
Commercial
 
2,279,628

 
1,949,734

Commercial construction, land and land development
 
499,639

 
419,611

Residential
 
632,412

 
607,990

Single family interim construction
 
248,425

 
187,984

Agricultural
 
51,684

 
50,178

Consumer
 
30,485

 
41,966

Other
 
160

 
124

   
 
4,360,690

 
3,989,405

Deferred loan fees
 
(1,898
)
 
(1,553
)
Allowance for loan losses
 
(29,575
)
 
(27,043
)
   
 
$
4,329,217

 
$
3,960,809


The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans.
Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. The Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. These cash flows, however, may not be as expected and the value of collateral securing the loans may fluctuate. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short term loans may be made on an unsecured basis. Additionally, our commercial loan portfolio includes loans made to customers in the energy industry, which is a complex, technical and cyclical industry. Experienced bankers with specialized energy lending experience originate our energy loans. Companies in this industry produce, extract, develop, exploit and explore for oil and natural gas. Loans are primarily collateralized with proven producing oil and gas reserves based on a technical evaluation of these reserves. At September 30, 2016 and December 31, 2015, there were approximately $ 112.5 million and $ 182.5 million of exploration and production (E&P) energy loans outstanding, respectively.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally largely dependent on the successful operation of the property or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors the diversification of the portfolio on a quarterly basis by type and geographic location. Management also tracks the level of owner occupied property versus non owner occupied property.
Land and commercial land development loans are underwritten using feasibility studies, independent appraisal reviews and financial analysis of the developers or property owners. Generally, borrowers must have a proven track record of success. Commercial construction loans are generally based upon estimates of cost and value of the completed project. These estimates may not be accurate. Commercial construction loans often involve the disbursement of substantial funds with the repayment dependent on the success of the ultimate project. Sources of repayment for these loans may be pre-committed permanent financing or sale of the developed property. The loans in this portfolio are geographically diverse and due to the increased risk are monitored closely by management and the board of directors on a quarterly basis.

11





Residential real estate and single family interim construction loans are underwritten primarily based on borrowers’ credit scores, documented income and minimum collateral values. Relatively small loan amounts are spread across many individual borrowers, which minimizes risk in the residential portfolio. In addition, management evaluates trends in past dues and current economic factors on a regular basis.
Agricultural loans are collateralized by real estate and/or agricultural-related assets. Agricultural real estate loans are primarily comprised of loans for the purchase of farmland. Loan-to-value ratios on loans secured by farmland generally do not exceed 80% and have amortization periods limited to twenty years. Agricultural non-real estate loans are generally comprised of term loans to fund the purchase of equipment, livestock and seasonal operating lines to grain farmers to plant and harvest corn and soybeans. Specific underwriting standards have been established for agricultural-related loans, including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary.
Agricultural loans carry significant credit risks as they involve larger balances concentrated with single borrowers or groups of related borrowers. In addition, repayment of such loans depends on the successful operation or management of the farm property securing the loan or for which an operating loan is utilized. Farming operations may be affected by adverse weather conditions such as drought, hail or floods that can severely limit crop yields.
Consumer loans represent less than 1% of the outstanding total loan portfolio. Collateral consists primarily of automobiles and other personal assets. Credit score analysis is used to supplement the underwriting process.
Most of the Company’s lending activity occurs within the State of Texas, primarily in the north, central and southeast Texas regions. A large percentage of the Company’s portfolio consists of commercial and residential real estate loans. As of September 30, 2016 and December 31, 2015 , there were no concentrations of loans related to a single industry in excess of 10% of total loans.
The allowance for loan losses is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio.
The allowance is derived from the following two components: 1) allowances established on individual impaired loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates, and 2) allowances based on actual historical loss experience for the last three years for similar types of loans in the Company’s loan portfolio adjusted for primarily changes in the lending policies and procedures; collection, charge-off and recovery practices; nature and volume of the loan portfolio; change in value of underlying collateral; volume and severity of nonperforming loans; existence and effect of any concentrations of credit and the level of such concentrations and current, national and local economic and business conditions. This second component also includes an unallocated allowance to cover uncertainties that could affect management’s estimate of probable losses. The unallocated allowance reflects the imprecision inherent in the underlying assumptions used in the methodologies for estimating this component.
The Company’s management continually evaluates the allowance for loan losses determined from the allowances established on individual loans and the amounts determined from historical loss percentages adjusted for the qualitative factors above. Should any of the factors considered by management change, the Company’s estimate of loan losses could also change and would affect the level of future provision expense. While the calculation of the allowance for loan losses utilizes management’s best judgment and all the information available, the adequacy of the allowance for loan losses is dependent on a variety of factors beyond the Company’s control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications.
In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses, and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

12





Loans requiring an allocated loan loss provision are generally identified at the servicing officer level based on review of weekly past due reports and/or the loan officer’s communication with borrowers. In addition, past due loans are discussed at weekly officer loan committee meetings to determine if classification is warranted. The Company’s credit department has implemented an internal risk based loan review process to identity potential internally classified loans that supplements the annual independent external loan review. The external review generally covers all loans greater than $2.9 million annually. These reviews include analysis of borrower’s financial condition, payment histories and collateral values to determine if a loan should be internally classified. Generally, once classified, an impaired loan analysis is completed by the credit department to determine if the loan is impaired and the amount of allocated allowance required.
The Texas economy, specifically the Company’s lending area of north, central and southeast Texas, has generally performed better than certain other parts of the country. However, the ongoing volatility in oil prices has the potential to have a negative impact on the Texas economy, specifically in Houston. The risk of loss associated with all segments of the portfolio could increase due to this impact. The Company increased its allowance for loan losses during the first quarter 2016 in consideration of this risk to the energy portfolio. Due to the stabilization of commodity prices and reductions to the energy portfolio, no additional allocations were warranted in second and third quarters 2016.
The economy and other risk factors are minimized by the Company’s underwriting standards, which include the following principles: 1) financial strength of the borrower including strong earnings, high net worth, significant liquidity and acceptable debt to worth ratio, 2) managerial business competence, 3) ability to repay, 4) loan to value, 5) projected cash flow and 6) guarantor financial statements as applicable. The following is a summary of the activity in the allowance for loan losses by loan class for the three and nine months ended September 30, 2016 and 2015 :
 
Commercial
Commercial
Real Estate,
Land and Land
Development
Residential
Real Estate
Single-Family
Interim
Construction
Agricultural
Consumer
Other
Unallocated
Total
Three months ended September 30, 2016
 
 

 

 

 
Balance at the beginning of period
$
11,357

$
15,492

$
2,533

$
1,121

$
175

$
171

$
28

$
39

$
30,916

Provision for loan losses
412

1,021

601

113

13

(6
)
23

(54
)
2,123

Charge-offs
(3,025
)

(421
)


(5
)
(33
)

(3,484
)
Recoveries
3

4

2



2

9


20

Balance at end of period
$
8,747

$
16,517

$
2,715

$
1,234

$
188

$
162

$
27

$
(15
)
$
29,575

 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2016
 
 
 
 
 
 
 
 
Balance at the beginning of period
$
10,573

$
13,007

$
2,339

$
769

$
215

$
164

$

$
(24
)
$
27,043

Provision for loan losses
2,378

3,558

786

465

(27
)
(2
)
76

9

7,243

Charge-offs
(4,216
)
(54
)
(421
)


(7
)
(78
)

(4,776
)
Recoveries
12

6

11



7

29


65

Balance at end of period
$
8,747

$
16,517

$
2,715

$
1,234

$
188

$
162

$
27

$
(15
)
$
29,575

 
 
 
 
 
 
 
 
 
 
Three months ended September 30, 2015
 
 
 
 
 
 
 
 
Balance at the beginning of period
$
6,632

$
11,720

$
2,318

$
738

$
234

$
181

$

$
(59
)
$
21,764

Provision for loan losses
3,866

318

(91
)
(19
)
(17
)
48


(173
)
3,932

Charge-offs
(500
)
(69
)
(9
)


(65
)


(643
)
Recoveries
17

7

1



10



35

Balance at end of period
$
10,015

$
11,976

$
2,219

$
719

$
217

$
174

$

$
(232
)
$
25,088

 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2015
 
 
 
 
 
 
 
 
Balance at the beginning of period
$
5,051

$
10,110

$
2,205

$
669

$
246

$
146

$

$
125

$
18,552

Provision for loan losses
5,547

1,898

18

50

(29
)
134


(357
)
7,261

Charge-offs
(606
)
(69
)
(9
)


(142
)


(826
)
Recoveries
23

37

5



36



101

Balance at end of period
$
10,015

$
11,976

$
2,219

$
719

$
217

$
174

$

$
(232
)
$
25,088


13





The following table details the amount of the allowance for loan losses and recorded investment in loans by class as of September 30, 2016 and December 31, 2015:
 
Commercial
Commercial
Real Estate,
Land and Land
Development
Residential
Real Estate
Single-Family
Interim
Construction
Agricultural
Consumer
Other
Unallocated
Total
September 30, 2016
 
 
 
 
 
 
 
 
 
Allowance for losses:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
125

$
4

$

$

$

$

$

$

$
129

Collectively evaluated for impairment
8,622

16,513

2,715

1,234

188

162

27

(15
)
29,446

Loans acquired with deteriorated credit quality









Ending balance
$
8,747

$
16,517

$
2,715

$
1,234

$
188

$
162

$
27

$
(15
)
$
29,575

 
 
 
 
 
 
 
 
 
 
Loans: