What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-10-22 compared with 2020-07-24 · 135 added, 137 removed, 408 unchanged (40% of the section changed)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition as of June 30, 2020 and December 31, 2019 and results of operations for the three and six month periods ended June 30, 2020 and June 30, 2019 should be read in conjunction with our consolidated financial statements and notes to the financial statements for the year ended December 31, 2019, and the other information included in the 2019 Form 10-K.

Certain risks, uncertainties and other factors, including those set forth under "Risk Factors" in Part I, Item 1A of the 2019 Form 10-K, and in Part II, Item 1A of this Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, may cause actual results to differ materially from the results discussed in the forward-looking statements appearing in this discussion and analysis.

The following discussion and analysis of our financial condition as of September 30, 2020 and December 31, 2019 and results of operations for the three and nine month periods ended September 30, 2020 and September 30, 2019 should be read in conjunction with our consolidated financial statements and notes to the financial statements for the year ended December 31, 2019, and the other information included in our Annual Report on Form 10-K for the year ended December 31, 2019 (the "2019 Form 10-K").

Certain risks, uncertainties and other factors, including those set forth under "Risk Factors" in Part I, Item 1A of the 2019 Form 10-K, and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, may cause actual results to differ materially from the results discussed in the forward-looking statements appearing in this discussion and analysis.

Forward-Looking Statements

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Changes in the U.S.

including the effects from declines in the level of drilling and production related to volatility in oil and gas prices and the effects of the COVID-19 pandemic.

economy in general or the Texas economy specifically resulting in deterioration of credit quality, increases in non-performing assets or charge-offs or reduced demand for credit or other financial services we offer, including the effects from declines in the level of drilling and production related to volatility in oil and gas prices and the effects of the COVID-19 pandemic.

Adverse changes in economic or market conditions, in Texas, the United States or internationally, that could affect the credit quality of our loan portfolio or our operating performance.

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The failure to effectively balance our funding sources with cash demands by depositors and borrowers.

The failure to manage information systems risk or to prevent cyber-attacks against us, our customers or our third party vendors, or to manage risks from disruptions or security breaches affecting us, our customers or our third party vendors, which risk risks have been materially enhanced by our increased reliance on technology to support associates working outside our offices.

The failure to manage information systems risk or to prevent cyber-attacks against us, our customers or our third party vendors, or to manage risks from disruptions or security breaches affecting us, our customers or our third party vendors, which risks have been materially enhanced by our increased reliance on technology to support associates working outside our offices.

The failure to effectively manage our interest rate risk resulting from unexpectedly large or sudden changes in interest rates, maturity imbalances in our assets and liabilities, potential adverse effects to our borrowers including their inability to repay loans with increased interest rates and the impact to our net interest income from the increasing cost of interest-bearing deposits.

The failure of our enterprise risk management framework, our compliance program, or our corporate governance and supervisory oversight functions to timely identify and address emerging risks adequately, which may result in unexpected losses.

Uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the potential transition away from LIBOR toward new interest rate benchmarks.

Legislative and regulatory changes imposing further restrictions and costs on our business, a failure to remain well capitalized or well managed status or regulatory enforcement actions against us, and uncertainty related to future implementation and enforcement of regulatory requirements resulting from the current political environment.

Uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the expected transition away from LIBOR toward new interest rate benchmarks.

Legislative and regulatory changes imposing further restrictions and costs on our business, a failure to maintain well capitalized or well managed status or regulatory enforcement actions against us, and uncertainty related to future implementation and enforcement of regulatory requirements resulting from the current political environment.

Changes in the monetary and fiscal policies of the U.S.

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Neither party paid a termination fee in connection with the termination of the merger agreement.

In response to the pressures of the current economic environment and a refinement of our strategy, we took actions during the second quarter of 2020 which are expected to decrease our non-interest expenses, including a workforce reduction and write-offs of certain software assets.

Significant transactions affecting our income statement during the second quarter of 2020 included:

In response to the pressures of the current economic environment and a refinement of our strategy, we took actions during the second and third quarters of 2020 which are expected to decrease our non-interest expenses, including a workforce reduction and write-offs of certain software assets.

Significant transactions affecting our income statement during the nine months ended September 30, 2020 included:

$226.0 million provision for credit losses;

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$18.0 million in severance accruals related to the workforce reduction referenced above,

$10.5 million in final merger-related expenses, and

$17.8 million in merger-related expenses, and

$20.9 million MSR impairment.

While these expenses had a significant impact on our second quarter operating results, we believe that we are better positioned to improve our core profitability going forward as the non-interest expense items are not expected to recur in future periods.

We continue to focus on balance sheet strength and while we intend to operate with above-average liquidity in response to this uncertain economic environment, we believe opportunities exist to improve core earnings by reducing or replacing higher cost funding sources and improving the earning asset mix.

In the first few weeks of July 2020, we began to utilize low-yielding liquidity assets to increase the balance of our securities portfolio in an effort to improve yields in future periods.

While these expenses had a significant impact on our year-to-date operating results, we believe that we are better positioned to improve our core profitability going forward as the non-interest expense items are not expected to recur in future periods.

We continue to focus on balance sheet strength and while we intend to operate with above-average liquidity in response to the uncertain economic environment, we believe opportunities exist to improve core earnings by reducing or replacing higher cost funding sources and improving the earning asset mix.

Our organic growth model and the depth of talent on our team have built a resilient business with lasting client relationships and a record of value creation through dynamic markets and business cycles.

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The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that we serve.

Governmental responses to the pandemic have included orders closing businesses not deemed essential and directing individuals to restrict their movements, observe social distancing and shelter in place.

These actions, together with responses to the pandemic by businesses and individuals, have resulted in rapid decreases in commercial and consumer activity, temporary closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains, market downturns and volatility, changes in consumer behavior related to pandemic fears, related emergency response legislation and an expectation that Federal Reserve policy will maintain a low interest rate environment for the foreseeable future.

Governmental responses to the pandemic included orders to close businesses not deemed essential and directing individuals to restrict their movements, observe social distancing and shelter in place.

These actions, together with responses to the pandemic by businesses and individuals, resulted in rapid decreases in commercial and consumer activity, temporary, and some permanent, closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains, market downturns and volatility, changes in consumer behavior related to pandemic fears, related emergency response legislation and an expectation that Federal Reserve policy will maintain a low interest rate environment for the foreseeable future.

Many of the more restrictive orders have been eased, allowing businesses to open and operate at higher capacities, which has boosted commercial and consumer activity during the third quarter of 2020.

The risk of future reimplementation of restrictions on businesses in response to increasing infection rates remains significant.

Legislative Developments

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The initial $350 billion program was supplemented in late April 2020 with $310 billion in additional funding.

On June 5, 2020, the Paycheck Protection Program Flexibility Act (the “new Act”) was signed into law, and made significant changes to the PPP to provide additional relief for small businesses.

The new Act increased flexibility for small businesses that have been unable to rehire employees due to lack of employee availability, or have been unable to operate as normal due to COVID-19 related restrictions.

It extended the period that businesses have to use PPP funds to qualify for loan forgiveness to 24 weeks, up from 8 weeks under the original rules.

The new Act also relaxed the requirements that loan recipients must adhere to in order to qualify for loan forgiveness.

On June 5, 2020, the Paycheck Protection Program Flexibility Act (the “new Act”) was signed into law, and made significant changes to the PPP to provide additional relief for small businesses, increasing flexibility for small businesses that have been unable to rehire employees due to lack of employee availability, or have been unable to operate as normal due to COVID-19 related restrictions, extending the period that businesses have to use PPP funds to qualify for loan forgiveness to 24 weeks, up from 8 weeks under the original rules, and relaxing the requirements that loan recipients must adhere to in order to qualify for loan forgiveness.

In addition, the new Act extended the payment deferral period for PPP loans until the date when the amount of loan forgiveness is determined and remitted to the lender.

For PPP recipients who do not apply for forgiveness, the loan deferral period is 10 months after the applicable forgiveness period ends.

The new Act did not extend the period for new applicants to seek PPP loans, which closed on June 30, 2020.

On July 4, 2020, Congress enacted a new law to extend the deadline for applying for a PPP loan to August 8, 2020.

We have partnered with a web-based commercial and SBA lending software provider to manage the origination, processing, closing and monitoring of SBA loans and have set up the Texas Capital Bank SBA PPP Loan Portal to provide borrowers the ability to apply and qualify for PPP loans.

As of June 30, 2020, we had funded $717.5 million in PPP loans.

As of September 30, 2020, we had funded $717.5 million in PPP loans.

Those loans have an outstanding balance of $715.0 million as of September 30, 2020.

We also implemented a short-term loan modification program in late March 2020 to provide temporary payment relief to borrowers who meet the program's qualifications.

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The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date of the existing loan.

As of June 30, 2020, we have granted temporary modifications on 482 loans with a total outstanding loan balance of $1.2 billion, resulting in the deferral of $10.8 million in interest payments.

Through September 30, 2020, we granted temporary modifications on 483 loans with a total outstanding loan balance of $1.3 billion, resulting in the deferral of $10.7 million in interest payments.

As of September 30, 2020 , 73 loans with a total outstanding balance of $166.2 million remain on deferral, of which $61.2 million have been granted a second deferral.

Impact on Our Financial Statements and Results of Operations

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As a result of the shelter-at-home mandate that was in force early in the second quarter of 2020, commercial activity throughout the state of Texas, as well as nationally, decreased significantly.

Most states have re-opened, albeit under limited capacities and under other social-distancing restrictions;

however commercial activity has not returned to the levels existing prior to the outbreak of the pandemic.

This decrease in commercial activity may result in our customers' inability to meet their loan obligations to us.

As of September 30, 2020, most regions in Texas have allowed businesses to re-open at limited capacities and with caution as to social-distancing and other restrictions.

Commercial activity has improved, but has not returned to the levels existing prior to the outbreak of the pandemic.

This continued depression in commercial activity may result in our customers' inability to meet their loan obligations to us.

In addition, the economic pressures and uncertainties related to the COVID-19 pandemic have resulted in changes in consumer spending behaviors, which may negatively impact the demand for loans and other services we offer.

Our business and consumer customers are experiencing varying degrees of financial distress, which is expected to continue for the remainder of 2020, especially if positive cases increase and further economic shut-downs are mandated.

Our business and consumer customers are experiencing varying degrees of financial distress, which is expected to continue for the remainder of 2020, especially if COVID-19 infections increase and new economic restrictions are mandated.

Our borrowing base includes customers in industries such as energy, hotel/lodging, restaurants, entertainment, retail and commercial real estate, all of which have been and are likely to continue to be significantly impacted by the COVID-19 pandemic.

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We have taken deliberate actions to ensure that we have the balance sheet strength to serve our clients and communities, including increases in liquidity and managing our assets and liabilities in order to maintain a strong capital position.

Current economic pressures and their effects on our customers, coupled with the implementation of the CECL expected loss methodology for determining our allowance for credit losses, have contributed to substantially increased provision for credit losses for the first six months of 2020.

We continue to monitor

closely the impact of the COVID-19 pandemic on our customers, as well as the effects of the CARES Act and the new Act.

Current economic pressures and their effects on our customers, coupled with the implementation of the CECL expected loss methodology for determining our allowance for credit losses, have contributed to a substantially increased provision for credit losses for the first nine months of 2020.

We continue to monitor closely the impact of the COVID-19 pandemic on our customers, as well as the effects of the CARES Act and the new Act.

Uncertainties associated with the pandemic include the duration of the outbreak, the impact to our customers, employees and vendors and the impact to the economy as a whole.

COVID-19 has had, and is expected to continue to have, a significant adverse impact on our business, financial position and operating results.

The extent to which the COVID-19 pandemic will impact our operations and financial results during the remainder of 2020 cannot be reasonably or reliably estimated at this time.

The extent to which the COVID-19 pandemic will impact our operations and financial results during the remainder of 2020 and in 2021 cannot be reasonably or reliably estimated at this time.

Impact on our Business Operations

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Energy Portfolio

Outstanding energy loans totaled $1.1 billion, or 4% of total loans, at June 30, 2020, compared to $1.4 billion at December 31, 2019 and $1.6 billion at June 30, 2019.

Outstanding energy loans totaled $969.0 million, or 4% of total loans, at September 30, 2020, compared to $1.4 billion, or 6% of total loans, at December 31, 2019 and $1.5 billion, or 6% of total loans, at September 30, 2019.

Our energy loan portfolio is primarily comprised of loans to exploration and production (“E&P”) companies that are generally collateralized with proven reserves based on appropriate valuation standards that take into account the risk of oil and gas price volatility.

At June 30, 2020, loans to E&P companies represented 84% of total energy loans outstanding.

At September 30, 2020, loans to E&P companies represented approximately 70% of total energy loans outstanding.

The majority of this portfolio consists of first lien, senior secured, reserve-based loans, which we believe is the lowest-risk form of energy lending.

At June 30, 2020 approximately 40% of our exposure was located in lower cost production areas such as the Permian Basin and Eagle Ford.

We recorded $62.4 million in energy net charge-offs during the three months ended June 30, 2020, all of which were previously identified as problem loans that experienced further deterioration during the second quarter of 2020 exacerbated by the continued low commodity prices.

Energy non-accruals totaled $103.9 million at June 30, 2020, $39.8 million of which relates to two loans that have been charged down to final resolution value and are expected to close in the third quarter of 2020, compared to $151.9 million at March 31, 2020 and $61.1 million at June 30, 2019.

At September 30, 2020 approximately 40% of our exposure was located in lower cost production areas such as the Permian Basin and Eagle Ford.

We recorded $739,000 in net recoveries during the three months ended September 30, 2020, compared to $62.4 million in net charge-offs during the three months ended June 30, 2020.

Energy non-accruals also improved during the third quarter of 2020, decreasing to $73.8 million at September 30, 2020 compared to $103.9 million at June 30, 2020 and $63.2 million at September 30, 2019.

We continue to proactively manage our energy portfolio and overall credit quality.

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Cash flows are assessed in the context of specific risk factors including commodity prices with corollary sensitivities, commodity hedges and select credit criteria.

Reserves allocated to energy loans totaled $102.7 million , or 9% of outstanding energy loans, at June 30, 2020, compared to $113.9 million at March 31, 2020 and $48.1 million at June 30, 2019.

At June 30, 2020 approximately 70% of our E&P clients are hedged 50% or more for 2020 and approximately 60% of our E&P clients are hedged 50% or more for 2021.

Reserves allocated to energy loans totaled $112.9 million , or 12% of outstanding energy loans, at September 30, 2020 , compared to $102.7 million, or 9% of outstanding energy loans, at June 30, 2020 and $45.4 million , or 3% of outstanding energy loans, at September 30, 2019.

At September 30, 2020 approximately 70% of our E&P clients are hedged 50% or more for 2020 and approximately 50% of our E&P clients are hedged 50% or more for 2021.

We believe that this hedge coverage compares favorably to the energy downturn experienced in 2015 and 2016.

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Summary of Performance

We reported a net loss of $34.3 million and net loss available to common stockholders of $36.8 million for the second quarter of 2020 compared to net income of $77.8 million and net income available to common stockholders of $75.4 million for the second quarter of 2019 .

On a fully diluted basis, earnings/(loss) per common share were $(0.73) for the second quarter of 2020 , compared to $1.50 for the second quarter of 2019 .

Return on average common equity (“ROE”) was (5.48)% and return on average assets ("ROA") was (0.36)% for the second quarter of 2020 , compared to 12.18% and 1.05% , respectively, for the second quarter of 2019 .

The decline in net income, ROE and ROA for the second quarter of 2020 resulted primarily from a $73.0 million increase in the provision for credit losses, as well as a $80.6 million increase in non-interest expense, driven by the significant second quarter 2020 expenses described below.

Net loss and net loss available to common stockholders for the six months ended June 30, 2020 totaled $51.0 million and $55.9 million , respectively compared to net income and net income available to common stockholders of $159.5 million and $154.6 million , respectively, for the same period in 2019 .

On a fully diluted basis, earnings/(loss) per common share were $(1.11) for the six months ended June 30, 2020 , compared to $3.07 for the same period in 2019 .

ROE was (4.16)% and ROA was (0.28)% for the six months ended June 30, 2020 compared to 12.77% and 1.14%, respectively, for the same period in 2019 .

We reported net income of $57.1 million and net income available to common stockholders of $54.7 million for the third quarter of 2020 compared to net income of $88.1 million and net income available to common stockholders of $85.6 million for the third quarter of 2019 .

On a fully diluted basis, earnings per common share were $1.08 for the third quarter of 2020 , compared to $1.70 for the third quarter of 2019 .

Return on average common equity (“ROE”) was 8.24% and return on average assets ("ROA") was 0.59% for the third quarter of 2020 , compared to 13.21% and 1.06% , respectively, for the third quarter of 2019 .

The decline in net income, ROE and ROA for the third quarter of 2020 resulted primarily from a $44.6 million decline net interest income and a $19.0 million increase in the provision for credit losses, offset by a $40.0 million increase in non-interest income.

Net income and net loss available to common stockholders for the nine months ended September 30, 2020 totaled $6.1 million and $1.2 million , respectively, compared to net income and net income available to common stockholders of $247.6 million and $240.3 million , respectively, for the same period in 2019 .

On a fully diluted basis, earnings/(loss) per common share were

$(0.02) for the nine months ended September 30, 2020 , compared to $4.77 for the same period in 2019 .

ROE was (0.06)% and ROA was 0.02% for the nine months ended September 30, 2020 compared to 12.92% and 1.11%, respectively, for the same period in 2019 .

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

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Consolidated Daily Average Balances, Average Yields and Rates

Three months ended June 30, 2020

Three months ended June 30, 2019

Three months ended September 30, 2020

Three months ended September 30, 2019

(in thousands except percentages)

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Yield on loans, net of reserves, less funding cost including all deposits and borrowed funds.

Six months ended June 30, 2020

Six months ended June 30, 2019

Nine months ended September 30, 2020

Nine months ended September 30, 2019

(in thousands except percentages)

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

Three months ended June 30, 2020/2019

Six months ended June 30, 2020/2019

Three months ended September 30, 2020/2019

Nine months ended September 30, 2020/2019

Change due to(1)

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Net Interest Income

Net interest income was $209.9 million for the three months ended June 30, 2020 compared to $243.6 million for the same period in 2019 .

Net interest income was $207.6 million for the three months ended September 30, 2020 , compared to $252.2 million for the same period in 2019 .

The decrease was primarily due to decreases in yields on earning assets and a shift in earning asset composition, offset by a decrease in funding costs.

Average earning assets for the three months ended June 30, 2020 increased by $7.9 billion compared to the same period in 2019 , including a $1.8 billion increase in average total loans held for investment, primarily from increases in average mortgage finance loans related to lower long-term interest rates, and an $8.2 billion increase in average liquidity assets, offset by a $2.1 billion decrease in average loans held for sale.

The increase in average liquidity assets was the result of actions taken by management in the first half of 2020 to ensure that we have the balance sheet strength to serve our clients during the COVID-19 pandemic.

Average earning assets for the three months ended September 30, 2020 increased by $5.5 billion compared to the same period in 2019 , including a $476.1 million increase in average total investment securities, reflecting our strategy of utilizing excess liquidity to build our investment portfolio, a $276.7 million increase in average total loans held for investment, primarily attributable to increases in average mortgage finance loans related to lower long-term interest rates, and a $6.8 billion increase in average liquidity assets, offset by a $2.0 billion decrease in average loans held for sale.

The increase in average liquidity assets was the result of actions taken by management in the first nine months of 2020 to ensure that we have the balance sheet strength to serve our clients during the COVID-19 pandemic.

While we intend to operate with above-average liquidity in response to the uncertain economic environment, we believe opportunities exist to improve core earnings by reducing or replacing higher-cost funding sources and improving the earning asset mix.

The decrease in average loans held for sale compared to the second quarter of 2019 resulted from holding purchased loans for shorter durations than in prior periods in order to limit exposure to forbearance risk caused by current economic uncertainties.

The resulting decline in net interest income on loans held for sale from shorter hold times was offset by an increase in non-interest income.

Average interest-bearing liabilities increased for the three months ended June 30, 2020 compared to the same period in 2019 and included a $5.3 billion increase in average interest-bearing deposits, offset by a $406.0 million decrease in average other borrowings.

Net interest margin for the three months ended June 30, 2020 was 2.30% compared to 3.41% for the same period in 2019 .

The decrease was primarily due to the effect of decreases in interest rates on earning asset yields, coupled with the shift in earning asset composition, primarily the increase in liquidity assets and decrease in loans held for sale, offset by lower funding costs compared to the second quarter of 2019.

The yield on total loans held for investment decreased to 3.88% for the three months ended June 30, 2020 compared to 5.15% for the same period in 2019 , and the yield on earning assets decreased to 2.76% for the three months ended June 30, 2020 compared to 4.84% for the same period in 2019 .

The average cost of total deposits and borrowed funds decreased to 0.43% for the second quarter of 2020 from 1.48% for the second quarter of 2019 .

The spread on total earning assets, net of the cost of deposits and borrowed funds, was 2.33% for the second quarter of 2020 compared to 3.36% for the second quarter of 2019 .

The decrease in average loans held for sale compared to the third quarter of 2019 resulted from holding purchased loans for shorter durations than in prior periods in order to limit exposure to forbearance risk caused by current economic uncertainties.

The decline in net interest income on loans held for sale resulting from shorter hold times was offset by an increase in non-interest income.

Average interest-bearing liabilities increased for the three months ended September 30, 2020 compared to the same period in 2019 and included a $3.3 billion increase in average interest-bearing deposits, offset by an $85.0 million decrease in average other borrowings.

Net interest margin for the three months ended September 30, 2020 was 2.22% compared to 3.16% for the same period in 2019 .

The decrease was primarily due to the effect of decreases in interest rates on earning asset yields, coupled with the shift in earning asset composition, primarily the increases in investment securities and liquidity assets and decreases in loans held for sale and loans held for investment, excluding mortgage finance, offset by lower funding costs compared to the third quarter of 2019.

The yield on total loans held for investment decreased to 3.71% for the three months ended September 30, 2020 compared to 4.87% for the same period in 2019 , and the yield on earning assets decreased to 2.60% for the three months ended September 30, 2020 compared to 4.44% for the same period in 2019 .

The average cost of total deposits and borrowed funds decreased to 0.36% for the third quarter of 2020 from 1.31% for the third quarter of 2019 .

The spread on total earning assets, net of the cost of deposits and borrowed funds, was 2.24% for the third quarter of 2020 compared to 3.13% for the third quarter of 2019 .

The decrease was primarily a result of declining loan yields offset by a decrease in the cost of interest-bearing liabilities.

Total funding costs, including all deposits, long-term debt and stockholders' equity, decreased to 0.45% for the second quarter of 2020 compared to 1.40% for 2019 .

Net interest income was $438.2 million for the six months ended June 30, 2020 compared to $479.2 million for the same period in 2019 .

Total funding costs, including all deposits, long-term debt and stockholders' equity, decreased to 0.38% for the third quarter of 2020 compared to 1.25% for the third quarter of 2019 .

Net interest income was $645.8 million for the nine months ended September 30, 2020 compared to $731.3 million for the same period in 2019 .

The decrease was primarily due to decreases in yields on earning assets and a shift in earning asset composition, offset by a decrease in funding costs.

Average earning assets increased for the six months ended June 30, 2020 compared to the same period in 2019 and included a $1.8 billion increase in average total loans held for investment and a $6.4 billion increase in average liquidity assets, offset by a $551.1 million decrease in average loans held for sale.

The increase in average liquidity assets was the result of deliberate actions taken by management as described above.

Average earning assets increased for the nine months ended September 30, 2020 , compared to the same period in 2019 and included a $191.9 million increase in average total investment securities, a $1.3 billion increase in average total loans held for investment and a $6.5 billion increase in average liquidity assets, offset by a $1.0 billion decrease in average loans held for sale.

The increases in average total investment securities and liquidity assets were the result of deliberate actions taken by management to enhance the strength of our balance sheet as described above.

The decrease in average loans held for sale was due to holding purchased loans for shorter durations as mentioned above.

Average interest-bearing liabilities increased for the six months ended June 30, 2020 compared to the same period in 2019 and included a $4.5 billion increase in average interest-bearing deposits and a $96.6 million increase in average other borrowings.

Net interest margin for the six months ended June 30, 2020 was 2.53% compared to 3.56% for 2019 .

The yield on total loans held for investment decreased to 4.13% for the six months ended June 30, 2020 compared to 5.28% for the prior year period and the yield on earning assets decreased to 3.22% for the six months ended June 30, 2020 compared to 4.99% for the same period in 2019 .

The average cost of total deposits and borrowed funds decreased to 0.68% for the six months ended June 30, 2020 from 1.47% for the same period in 2019 .

Average interest-bearing liabilities increased for the nine months ended September 30, 2020 , compared to the same period in 2019 , and included a $4.1 billion increase in average interest-bearing deposits and a $36.0 million increase in average other borrowings.

Net interest margin for the nine months ended September 30, 2020 was 2.42% compared to 3.41% for the same period of 2019 .

The decrease was primarily due to the effect of decreases in interest rates on earning asset yields, coupled with the shift in earning asset composition, primarily the increases in investment securities and liquidity assets and decrease in loans held for sale, offset by lower funding costs compared to the same period in 2019.

The yield on total loans held for investment decreased to 3.99% for the nine months ended September 30, 2020 , compared to 5.13% for the prior year period, and the yield on earning assets decreased to 3.00% for the nine months ended September 30, 2020 , compared to 4.78% for the same period in 2019 .

The average cost of total deposits and borrowed funds decreased to 0.56% for the nine months ended September 30, 2020 from 1.41% for the same period in 2019 .

The spread on total earning assets, net of the cost of deposits and borrowed funds, was 2.44% for 2020 compared to 3.37% for 2019 .

The decrease was primarily a result of a declining loan yields offset by a decrease in the cost of interest-bearing liabilities.

Total funding costs, including all deposits, long-term debt and stockholders' equity decreased to 0.67% for the six months ended June 30, 2020 compared to 1.39% for the same period in 2019 .

Total funding costs, including all deposits, long-term debt and stockholders' equity decreased to 0.57% for the nine months ended September 30, 2020 , compared to 1.34% for the same period in 2019 .

Non-interest Income

Three months ended June 30,

Six months ended June 30,

Three months ended September 30,

Nine months ended September 30,

(in thousands)

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Other non-interest income includes such items as letter of credit fees, bank owned life insurance ("BOLI") income, dividends on FHLB and FRB stock, income from legal settlements and other general operating income.

Non-interest income increased by $46.1 million during the three months ended June 30, 2020 to $70.5 million , compared to $24.4 million for the same period in 2019 .

This increase was primarily due to a $45.0 million increase in net gain/(loss) on sale of loans held for sale, a $3.4 million increase in brokered loan fees and a $3.0 million increase in servicing income, partially offset by a $6.0 million decrease in other non-interest income.

The increase in net gain/(loss) on sale of loans held for sale was due to favorable economics and lower hedge costs in the second quarter of 2020 as a result of holding purchased loans for shorter durations than in prior periods, which is offset by the decline in net interest income on loans held for sale noted above.

The increase in brokered loan fees was due to an increase in total mortgage finance volumes during the three months ended June 30, 2020 compared to the same period in 2019 , and the increase in servicing income was due to an overall increase in MSR balances held.

The decrease in other non-interest income resulted primarily from $6.5 million in settlements of legal claims during the second quarter of 2019 not present in 2020.

Non-interest income increased by $27.9 million during the six months ended June 30, 2020 to $82.3 million , compared to $54.4 million for the same period in 2019 .

This increase was primarily due to a $32.5 million increase in net gain/(loss) on sale of loans held for sale, a $6.4 million increase in brokered loans fees and a $5.0 million increase in servicing income, partially offset by a $19.2 million decrease in other non-interest income.

The increase in net gain/(loss) on sale of loans held for sale was due to favorable economics and lower hedge costs in 2020 as a result of holding purchased loans for shorter durations than in prior periods.

The increase in brokered loan fees was due to an increase in total mortgage finance volumes during the six months ended June 30, 2020 compared to the same period in 2019 , and the increase in servicing income was due to an overall increase in MSR balances held.

The decrease in other non-interest income resulted primarily from $15.0 million in settlements of legal claims during the six months ended June 30, 2019 not present in 2020.

Non-interest income increased by $40.0 million during the three months ended September 30, 2020 to $60.3 million , compared to $20.3 million for the same period in 2019 .

This increase was primarily due to a $31.3 million increase in net gain/(loss) on sale of loans held for sale and a $6.3 million increase in brokered loan fees.

The increase in net gain/(loss) on sale of loans held for sale was due to favorable economics and lower hedge costs in the third quarter of 2020 as a result of holding purchased loans for shorter durations than in prior periods, which was offset by the decline in net interest income on loans held for sale noted above.

The increase in brokered loan fees was due to an increase in total mortgage finance volumes during the three months ended September 30, 2020 compared to the same period in 2019 .

Non-interest income increased by $68.0 million during the nine months ended September 30, 2020 to $142.6 million , compared to $74.7 million for the same period in 2019 .

This increase was primarily due to a $63.8 million increase in net gain/(loss) on sale of loans held for sale, a $12.7 million increase in brokered loans fees and an $8.8 million increase in servicing income, partially offset by a $20.1 million decrease in other non-interest income.

The increase in net gain/(loss) on sale of loans held for

sale was due to favorable economics and lower hedge costs in 2020 as a result of holding purchased loans for shorter durations than in prior periods.

The increase in brokered loan fees was due to an increase in total mortgage finance volumes during the nine months ended September 30, 2020 , compared to the same period in 2019 , and the increase in servicing income was due to an overall increase in MSR balances held.

The decrease in other non-interest income resulted primarily from $15.0 million in settlements of legal claims during the nine months ended September 30, 2019 not present in 2020.

While management expects continued growth in certain components of non-interest income, the future rate of growth could be affected by increased competition from national and regional financial institutions and general economic conditions.

achieve continued growth in non-interest income, management from time to time evaluates new products, new lines of business or the expansion of existing lines of business.

In order to achieve continued growth in non-interest income, management from time to time evaluates new products, new lines of business or the expansion of existing lines of business.

Any new product introduction or new market entry could place additional demands on capital and managerial resources and introduce new risks to our business.

Non-interest Expense

Three months ended June 30,

Six months ended June 30,

Three months ended September 30,

Nine months ended September 30,

(in thousands)

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Other expense includes such items as courier expenses, regulatory assessments other than FDIC insurance, insurance expenses and other general operating expenses.

Non-interest expense for the three months ended June 30, 2020 increased $80.6 million compared to the same period in 2019 .

The increase was primarily due to increases in salaries and employee benefits, communications and technology expenses, servicing-related expenses and merger-related expenses.

The increases in salaries and employee benefits and communications and technology expense were primarily due to $18.0 million in severance accruals and $26.6 million in non-recurring software expenses;

including $20.7 million in write-offs of certain software assets and $5.9 million in technology expense related to the roll-out of our PPP capability, respectively, mentioned above.

The increase in servicing-related expenses was primarily due to higher MSR amortization expense resulting from an increase in the cost basis of our MSR asset as well as from higher mortgage prepayment rates, and an increase in impairment expense.

Non-interest expense for the six months ended June 30, 2020 increased $104.5 million compared to 2019 .

The increase was primarily due to increases in salaries and employee benefits, communication and technology, servicing-related expenses and merger-related expenses.

Non-interest expense for the three months ended September 30, 2020 increased $16.3 million compared to the same period in 2019 .

The increase was primarily due to an increase in communications and technology expenses, primarily due to the write-off of $15.4 million in software assets in the three months ended September 30, 2020 , partially offset by a decrease in marketing expense.

Non-interest expense for the nine months ended September 30, 2020 increased $120.8 million compared to 2019 .

The increase was primarily due to increases in salaries and employee benefits, communication and technology, servicing-related expenses and merger-related expenses, partially offset by a decrease in marketing expenses.

The increases in salaries and employee benefits and communications and technology expense were primarily due to the severance accruals and non-recurring software expenses, respectively, mentioned above.

The full impact on salaries and employee benefits expense from the reduction in workforce and on software amortization expense from the software write-offs recorded in the nine months ended September 30, 2020 is expected to be realized in non-interest expense in the first half of 2021, with meaningful reductions in run-rate occurring in the fourth quarter of 2020.

Further software write-offs are not expected in the fourth quarter of 2020.

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The following table summarizes our loans held for investment on a gross basis by portfolio segment:

June 30, 2020

September 30, 2020

December 31, 2019

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Total loans held for investment, net

Mortgage finance loans relate to our mortgage warehouse lending operations in which we purchase mortgage loan ownership interests that are typically sold within 10 to 20 days and represent 36% of total loans held for investment at June 30, 2020 , an increase compared to 33% at December 31, 2019.

Mortgage finance loans relate to our mortgage warehouse lending operations in which we purchase mortgage loan ownership interests that are typically sold within 10 to 20 days and represent 38% of total loans held for investment at September 30, 2020 , an increase compared to 33% at December 31, 2019.

Volumes fluctuate based on the level of market demand for the product and the number of days between purchase and sale of the loans, which can be affected by changes in overall market interest rates and tend to peak at the end of each month.

Traditional loans held for investment also increased during the first six months of 2020.

The majority of the loan growth was in our real estate portfolio, offset by a decline in our energy portfolio.

the strategy of planned reductions in portfolios that have experienced higher historic losses, primarily energy and leveraged lending.

Traditional loans held for investment decreased 4% during the first nine months of 2020.

The majority of the decrease was in our commercial and energy portfolios, and was partially offset by the addition of $715.0 million in PPP loan balances at September 30, 2020.

We continue the strategy of planned reductions in portfolios that have experienced higher historic losses, primarily energy and leveraged lending.

We originate a substantial majority of all loans held for investment.

We also participate in syndicated loan relationships, both as a participant and as an agent.

As of June 30, 2020 , we had $2.1 billion in syndicated loans, $464.6 million of which we administer as agent.

As of September 30, 2020 , we had $1.8 billion in syndicated loans, $449.7 million of which we administer as agent.

All syndicated loans, whether we act as agent or participant, are underwritten to the same standards as all other loans we originate.

As of June 30, 2020 , $4.1 million of our syndicated loans were on non-accrual.

As of September 30, 2020 , $473,000 of our syndicated loans were on non-accrual.

Portfolio Geographic and Industry Concentrations

Although more than 50% of our total loan exposure is outside of Texas and more than 50% of our deposits are sourced outside of Texas, our Texas concentration remains significant.

As of June 30, 2020 , a majority of our loans held for investment, excluding mortgage finance loans and other national lines of business, were to businesses with headquarters or operations in Texas.

As of September 30, 2020 , a majority of our loans held for investment, excluding mortgage finance loans and other national lines of business, were to businesses with headquarters or operations in Texas.

This geographic concentration subjects the loan portfolio to the general economic conditions within this state.

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(in thousands)

June 30, 2020

September 30, 2020

December 31, 2019

June 30, 2019

September 30, 2019

Non-accrual loans(1)

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Loans held for sale past due 90 days and accruing(3)

As of June 30, 2020 , December 31, 2019 and June 30, 2019 , non-accrual loans included $23.7 million , $35.1 million and $32.0 million , respectively, in loans that met the criteria for restructured.

At June 30, 2020 , December 31, 2019 and June 30, 2019 , loans past due 90 days and still accruing includes premium finance loans of $14.8 million , $8.5 million and $9.8 million, respectively.

As of September 30, 2020 , December 31, 2019 and September 30, 2019 , non-accrual loans included $47.7 million , $35.1 million and $15.5 million , respectively, in loans that met the criteria for restructured.

At September 30, 2020 , December 31, 2019 and September 30, 2019 , loans past due 90 days and still accruing includes premium finance loans of $11.9 million , $8.5 million and $9.2 million, respectively.

Includes loans guaranteed by U.S.

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Also includes loans that, pursuant to Ginnie Mae servicing guidelines, we have the unilateral right, but not the obligation, to repurchase if defined delinquent loan criteria are met and therefore must record as loans held for sale on our balance sheet regardless of whether the repurchase option has been exercised.

Total non-performing assets at June 30, 2020 decreased $51.4 million from December 31, 2019 and increased $59.9 million compared to June 30, 2019 .

The decrease from December 31, 2019 was primarily related to charge-offs of energy and leveraged lending loans during the first six months of 2020.

The year-over-year increase is primarily related to our energy and leveraged lending portfolios.

Non-accrual energy loans totaled $103.9 million ( 60% of total NPAs) at June 30, 2020 , $39.8 million of which relates to two loans that have been charged down to final resolution value and are expected to close in the third quarter of 2020, compared to $61.1 million at June 30, 2019 .

Non-accrual leveraged lending loans totaled $24.8 million ( 14% of total NPAs) at June 30, 2020 compared to $25.0 million at June 30, 2019 .

The COVID-19 pandemic has had an

adverse effect on our non-performing assets and, based on the current trajectory, we anticipate that continued adverse impacts will occur in subsequent quarters.

Total non-performing assets at September 30, 2020 decreased $63.4 million from December 31, 2019 and increased $41.3 million compared to September 30, 2019 .

The decrease from December 31, 2019 was primarily related to charge-offs of energy and leveraged lending loans during the first nine months of 2020.

The year-over-year increase is primarily related to our energy and real estate portfolios.

Non-accrual energy loans totaled $73.8 million ( 46% of total NPAs) at September 30, 2020 , compared to $63.2 million (52% of total NPAs) at September 30, 2019 .

Non-accrual leveraged lending loans totaled $31.3 million ( 19% of total NPAs) at September 30, 2020 compared to $28.3 million (23% of total NPAs) at September 30, 2019 .

The COVID-19 pandemic has had an adverse effect on our non-performing assets and, based on the current trajectory, we anticipate that continued adverse impacts will occur in subsequent quarters.

Potential problem loans consist of loans that are performing in accordance with contractual terms, but for which we have concerns about the borrower’s ability to comply with repayment terms because of the borrower’s potential financial difficulties.

We monitor these loans closely and review their performance on a regular basis.

At June 30, 2020 , we had $132.0 million in loans of this type, compared to $46.6 million at December 31, 2019 and $44.9 million at June 30, 2019 .

At September 30, 2020 , we had $129.5 million in loans of this type, compared to $46.6 million at December 31, 2019 and $58.2 million at September 30, 2019 .

Summary of Credit Loss Experience

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Upon adoption, the allowance for credit losses was increased by $9.1 million, with no impact on the consolidated statement of income.

We recorded a $100.0 million provision for credit losses for the second quarter of 2020 , compared to $96.0 million in the first quarter of 2020 and $27.0 million in the second quarter of 2019.

The increase resulted primarily from an increase in charge-offs and reserve build related to higher criticized loan levels and continued economic uncertainty related to the COVID-19 pandemic.

We recorded $74.1 million in net charge-offs during the second quarter of 2020, including $62.4 million in energy net charge-offs and $8.1 million in leveraged lending net charge-offs, compared to $57.7 million during the first quarter of 2020 and $20.0 million during the second quarter of 2019.

Criticized loans totaled $1.0 billion at June 30, 2020 , compared to $675.9 million at March 31, 2020 and $629.1 million at June 30, 2019 .

The increase in criticized loans was predominantly in special mention and was primarily related to the continued downgrade of loans to borrowers that have been impacted by COVID-19 or that are in industries that are expected to be more significantly impacted by COVID-19.

We recorded a $30.0 million provision for credit losses for the third quarter of 2020 , compared to $100.0 million in the second quarter of 2020 and $11.0 million in the third quarter of 2019.

The decrease from the second quarter of 2020 resulted primarily from a decrease in charge-offs.

We recorded $1.6 million in net charge-offs during the third quarter of 2020, compared to $74.1 million during the second quarter of 2020 and $36.9 million during the third

quarter of 2019.

Criticized loans totaled $1.1 billion at September 30, 2020 , compared to $1.0 billion at June 30, 2020 and $536.4 million at September 30, 2019 .

Criticized loan levels remain elevated due to the downgrade of loans to borrowers that have been impacted by the COVID-19 pandemic or that are in categories that are expected to be more significantly impacted by COVID-19.

The table below presents a summary of our loan loss experience:

Six months ended June 30, 2020

Nine months ended September 30, 2020

Year ended December 31, 2019

Six months ended June 30, 2019

Nine months ended September 30, 2019

(in thousands except percentage and multiple data)

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Allowance as a multiple of non-performing loans

The allowance for credit losses, including the allowance for losses on unfunded commitments reported on the consolidated balance sheets in other liabilities, totaled $277.0 million at June 30, 2020 , $203.7 million at December 31, 2019 and $225.4 million at June 30, 2019 .

The combined allowance as a percentage of loans held for investment increased to 1.09% at June 30, 2020 from 0.83% at December 31, 2019 and 0.93% at June 30, 2019 .

The combined allowance as a percentage of loans held for investment, excluding mortgage finance, increased to 1.67% at June 30, 2020 from 1.24% at December 31, 2019 and 1.33% at June 30, 2019 .

The increase in the combined allowance as a percentage of loans held for investment at June 30, 2020 compared to June 30, 2019 is due primarily to an increase in the allowance for credit losses, resulting from reserve build related to higher criticized loan levels and continued economic uncertainty related to the COVID-19 pandemic.

The allowance for credit losses, including the allowance for losses on unfunded commitments reported on the consolidated balance sheets in other liabilities, totaled $305.4 million at September 30, 2020 , $203.7 million at December 31, 2019 and $199.5 million at September 30, 2019 .

The combined allowance as a percentage of loans held for investment increased to 1.21% at September 30, 2020 , from 0.83% at December 31, 2019 and 0.81% at September 30, 2019 .

The combined allowance as a percentage of loans held for investment, excluding mortgage finance, increased to 1.93% at September 30, 2020 from 1.24% at December 31, 2019 and 1.19% at September 30, 2019 .

The increase in the combined allowance as a percentage of loans held for investment at September 30, 2020 , compared to September 30, 2019 , is due primarily to an increase in the allowance for credit losses, resulting from reserve build related to higher criticized loan levels and continued economic uncertainty related to the COVID-19 pandemic.

Loans Held for Sale

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We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost-effectiveness.

For the year ended December 31, 2019 and the six months ended June 30, 2020 , our principal source of funding has been our customer deposits, supplemented by our short-term and long-term borrowings, primarily from federal funds purchased and FHLB borrowings, which are generally used to fund mortgage finance assets.

For the year ended December 31, 2019 and the nine months ended September 30, 2020 , our principal source of funding has been our customer deposits, supplemented by our short-term and long-term borrowings, primarily from federal funds purchased and FHLB borrowings, which are generally used to fund mortgage finance assets.

We also rely on the availability of the mortgage secondary market provided by Ginnie Mae and the GSEs to support the liquidity of our mortgage finance assets.

In accordance with our liquidity strategy, deposit growth and increases in borrowing capacity related to our mortgage finance loans have resulted in accumulating liquidity assets in recent periods.

Additionally, in the first six months of 2020 we significantly increased our liquidity assets to ensure that we have the balance sheet strength to serve our clients during the COVID-19 pandemic.

Additionally, throughout 2020 we have significantly increased our liquidity assets to ensure that we have the balance sheet strength to serve our clients during the COVID-19 pandemic.

The following table summarizes the composition of liquidity assets:

(in thousands except percentage data)

June 30, 2020

September 30, 2020

December 31, 2019

June 30, 2019

September 30, 2019

Federal funds sold and securities purchased under resale agreements

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Total deposits

Our liquidity needs to support growth in loans held for investment have been fulfilled primarily through growth in our core customer deposits.

Our liquidity requirements to support growth in loans held for investment have been fulfilled primarily through growth in our core customer deposits.

Our goal is to obtain as much of our funding for loans held for investment and other earning assets as possible from deposits of these core customers.

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(in thousands)

June 30, 2020

September 30, 2020

December 31, 2019

June 30, 2019

September 30, 2019

Deposits from core customers

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(in thousands)

June 30, 2020

September 30, 2020

Federal funds purchased

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The following table summarizes our other borrowing capacities net of balances outstanding.

As of June 30, 2020 , all are scheduled to mature within one year.

As of September 30, 2020 , all are scheduled to mature within one year.

(in thousands)

June 30, 2020

September 30, 2020

FHLB borrowing capacity relating to loans

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The loan agreement contains customary financial covenants and restrictions.

No borrowings were made against this line of credit during the six months ended June 30, 2020 .

Our equity capital averaged $2.8 billion for the three months ended June 30, 2020 as compared to $2.6 billion for the same period in 2019 .

No borrowings were made against this line of credit during the nine months ended September 30, 2020 .

Our equity capital averaged $2.8 billion for the three months ended September 30, 2020 as compared to $2.7 billion for the same period in 2019 .

We have not paid any cash dividends on our common stock since we commenced operations and have no plans to do so in the foreseeable future.

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Commitments and Contractual Obligations

The following table presents, as of June 30, 2020 , significant fixed and determinable contractual obligations to third parties by payment date.

The following table presents, as of September 30, 2020 , significant fixed and determinable contractual obligations to third parties by payment date.

Amounts in the table do not include accrued or accruing interest.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis