Item 2. Management’s Discussion and Analysis
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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
Certain statements and financial analysis contained in this report that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of federal securities laws. Forward-looking statements may also be contained in our future filings with SEC, in press releases and in oral and written statements made by us or with our approval that are not statements of historical fact. These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information available to us at the time such statements are made. Words such as “believes,” “expects,” “estimates,” “anticipates,” “plans,” “goals,” “objectives,” “expects,” “intends,” “seeks,” “likely,” “targeted,” “continue,” “remain,” “will,” “should,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements may include, among other things, statements about the credit quality of our loan portfolio, general economic conditions in the United States and in our markets, including the continued impact on our customers from volatility in oil and gas prices, the material risks and uncertainties for the U.S. and world economies, and for our business, resulting from the novel Coronavirus Disease 2019 ("COVID-19") pandemic, expectations regarding rates of default and loan losses, volatility in the mortgage industry, our business strategies and our expectations about future financial performance, future growth and earnings, the appropriateness of our allowance for credit losses and provision for credit losses, the impact of changing regulatory requirements and legislative changes on our business, increased competition, interest rate risk, new lines of business, new product or service offerings and new technologies.
Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management’s expectations and assumptions at the time the statements are made and are not guarantees of future results. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, the following:
•
Deterioration of the credit quality of our loan portfolio or declines in the value of collateral related to external factors such as commodity prices, real estate values or interest rates, increased default rates and loan losses or adverse changes in the industry concentrations of our loan portfolio.
•
The COVID-19 pandemic is adversely affecting us and our customers, employees and third-party service providers; the adverse impacts of the pandemic on our business, financial position, operations and prospects have been material. It is not possible to accurately predicts the extent, severity or duration of the pandemic or when normal economic and operational conditions will return.
•
Operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which we are highly dependent.
•
Changes in interest rates, which may affect our net income and other future cash flows, or the market value of our assets, including the market value of investment securities.
•
Changes in our ability to access the capital markets, including changes in our credit ratings.
•
Changes in the value of commercial and residential real estate securing our loans or in the demand for credit to support the purchase and ownership of such assets.
•
Changing economic conditions or other developments adversely affecting our commercial, entrepreneurial and professional customers.
•
Adverse economic conditions and other factors affecting our middle market customers and their ability to continue to meet their loan obligations.
•
The failure to correctly assess and model the assumptions supporting our allowance for credit losses, causing it to become inadequate in the event of deteriorations in loan quality and increases in charge-offs, or increases or decreases to our allowance for credit losses as a result of the implementation of CECL.
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•
Changes in the U.S. 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.
•
Unanticipated effects from the Tax Cuts and Jobs Act of 2017 may limit its benefits or adversely impact our business, which could include decreased demand for borrowing by our middle market customers or increased price competition that offsets the benefits of decreased federal income tax expense.
•
Unexpected market conditions or regulatory changes that could cause access to capital market transactions and other sources of funding to become more difficult to obtain on terms and conditions that are acceptable to us.
•
The inadequacy of our available funds to meet our deposit, debt and other obligations as they become due, or our failure to maintain our capital ratios as a result of adverse changes in our operating performance or financial condition, or changes in applicable regulations or regulator interpretation of regulations impacting our business or the characterization or risk weight of our assets.
•
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 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 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. Government, including policies of the U.S. Department of Treasury and the Federal Reserve.
•
The failure to successfully execute our business strategy, which may include expanding into new markets, developing and launching new lines of business or new products and services within the expected timeframes and budgets or to successfully manage the risks related to the development and implementation of these new businesses, products or services.
•
The failure to attract and retain key personnel or the loss of key individuals or groups of employees, including our ability to identify, employ and retain a successor chief executive officer.
•
Increased or more effective competition from banks and other financial service providers in our markets.
•
Structural changes in the markets for origination, sale and servicing of residential mortgages.
•
Uncertainty in the pricing of mortgage loans that we purchase, and later sell or securitize, as well as competition for the MSRs related to these loans and related interest rate risk or price risk resulting from retaining MSRs, and the potential effects of higher interest rates on our Mortgage Correspondent Aggregation ("MCA") loan volumes.
•
Changes in accounting principles, policies, practices or guidelines.
•
Volatility in the market price of our common stock.
•
Material failures of our accounting estimates and risk management processes based on management judgment, or the supporting analytical and forecasting models.
•
Failure of our risk management strategies and procedures, including failure or circumvention of our controls.
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•
Credit risk resulting from our exposure to counterparties.
•
An increase in the incidence or severity of fraud, illegal payments, security breaches and other illegal acts impacting our Bank and our customers.
•
The failure to maintain adequate regulatory capital to support our business.
•
Unavailability of funds obtained from borrowing or capital transactions or from our Bank to fund our obligations.
•
Incurrence of material costs and liabilities associated with legal and regulatory proceedings, investigations, inquiries and related matters with respect to the financial services industry, including those directly involving us or our Bank and arising from our participation in government stimulus programs responding to the economic impact of the COVID-19 pandemic.
•
Environmental liability associated with properties related to our lending activities.
•
Severe weather, natural disasters, acts of war or terrorism and other external events.
Actual outcomes and results may differ materially from what is expressed in our forward-looking statements and from our historical financial results due to the factors discussed elsewhere in this report or disclosed in our other SEC filings. Forward-looking statements included herein speak only as of the date hereof and should not be relied upon as representing our expectations or beliefs as of any date subsequent to the date of this report. Except as required by law, we undertake no obligation to revise any forward-looking statements contained in this report, whether as a result of new information, future events or otherwise. The factors discussed herein are not intended to be a complete summary of all risks and uncertainties that may affect our businesses. Though we strive to monitor and mitigate risk, we cannot anticipate all potential economic, operational and financial developments that may adversely impact our operations and our financial results. Forward-looking statements should not be viewed as predictions and should not be the primary basis upon which investors evaluate an investment in our securities.
Overview of Our Business Operations
We commenced our banking operations in December 1998. An important aspect of our growth strategy has been our ability to effectively service and manage a large number of loans and deposit accounts in multiple markets in Texas, as well as several lines of business serving a regional or national clientele of commercial borrowers. Accordingly, we have created an operations infrastructure sufficient to support our lending and banking operations that we continue to build out as needed to serve a larger customer base and specialized industries.
On December 9, 2019, we and Independent Bank Group, Inc. ("IBTX") entered into a merger agreement to combine the companies in an all-stock merger of equals. On May 22, 2020, we and IBTX mutually agreed to terminate the merger agreement. The termination was approved by each company's board of directors after careful consideration of the significant impact of the COVID-19 pandemic on global markets and on the companies' ability to fully realize the benefits expected to be achieved through the merger. 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 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; driven by an increase in charge-offs and reserve build related to higher criticized loan levels and continued economic uncertainty from the COVID-19 pandemic,
•
$42.1 million in non-recurring software expenses; including $36.2 million in write-offs of certain software assets and $5.9 million in technology expense related to the roll-out of our Paycheck Protection Program ("PPP") capabilities,
•
$18.0 million in severance accruals related to the workforce reduction referenced above,
•
$17.8 million in merger-related expenses, and
•
$20.9 million MSR impairment.
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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Impact of COVID-19
Overview
In March 2020, the outbreak of COVID-19 was recognized as a pandemic by the World Health Organization. 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 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
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security ("CARES") Act was signed into law. It contained substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act included the PPP, a nearly $350 billion program designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans were intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. 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, 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. 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 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. This program allows for a deferral of payments for 90 days, which we may extend for an additional 90 days, for a maximum of 180 days on a cumulative basis. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date of the existing loan. 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
Financial institutions are dependent upon the ability of their loan customers to meet their loan obligations and the availability of their workforce and vendors. 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. 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 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. We continue to monitor these customers closely.
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Future economic conditions are subject to significant uncertainty. 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 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 and in 2021 cannot be reasonably or reliably estimated at this time.
Impact on our Business Operations
In order to protect the health of our customers and employees, and to comply with applicable government directives, we have modified our business practices, including restricting employee travel, directing employees to work from home insofar as is possible and implementing our business continuity plans and protocols to the extent necessary. Since early March 2020, approximately 90% of our workforce has been working virtually with limited impact on the execution of our business and client experience. We expect to be able to continue with this strategy for the foreseeable future. When the decision is made to transition employees back into the office locations, our Business Continuity team has a plan in place to phase employees back into the office locations over an extended period of time. Our branch locations are currently open and operating during normal business hours, although customers are admitted into the branches only between the hours of 10:00 a.m. and 2:00 p.m. We are taking additional precautions within our branch locations, including enhanced cleaning procedures, to ensure the safety of our customers and our employees.
Energy Portfolio
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 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 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. Energy loans are reviewed quarterly and a formal borrowing base re-determination for reserve-based loans is completed semi-annually to ensure that borrowing capacity is commensurate with asset values. 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 $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.
Results of Operations
Summary of Performance
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 $240.3 million , respectively, for the same period in 2019 . On a fully diluted basis, earnings/(loss) per common share were
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$(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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QUARTERLY FINANCIAL SUMMARIES – UNAUDITED
Consolidated Daily Average Balances, Average Yields and Rates
Three months ended September 30, 2020
Three months ended September 30, 2019
(in thousands except percentages)
Average
Balance
Revenue/
Expense
Yield/
Rate
Average
Balance
Revenue/
Expense
Yield/
Rate
Assets
Investment securities – taxable
$
525,149
$
1,905
1.44
%
$
39,744
$
357
3.56
%
Investment securities – non-taxable(2)
190,797
2,239
4.67
%
200,090
2,480
4.92
%
Federal funds sold and securities purchased under resale agreements
12,051
1
0.04
%
100,657
554
2.18
%
Interest-bearing deposits in other banks
11,028,962
2,877
0.10
%
4,184,217
22,887
2.17
%
Loans held for sale
543,606
3,867
2.83
%
2,555,269
26,206
4.07
%
Loans held for investment, mortgage finance
9,061,984
76,464
3.36
%
8,118,025
68,660
3.36
%
Loans held for investment(1)(2)
16,286,036
157,230
3.84
%
16,901,391
235,557
5.53
%
Less reserve for credit losses on loans
264,769
—
—
212,898
—
—
Loans held for investment, net
25,083,251
233,694
3.71
%
24,806,518
304,217
4.87
%
Total earning assets
37,383,816
244,583
2.60
%
31,886,495
356,701
4.44
%
Cash and other assets
1,037,760
1,000,117
Total assets
$
38,421,576
$
32,886,612
Liabilities and Stockholders’ Equity
Transaction deposits
$
4,275,574
$
6,652
0.62
%
$
3,577,905
$
18,442
2.04
%
Savings deposits
12,786,719
12,808
0.40
%
10,331,078
45,586
1.75
%
Time deposits
2,844,083
8,370
1.17
%
2,706,434
16,939
2.48
%
Total interest-bearing deposits
19,906,376
27,830
0.56
%
16,615,417
80,967
1.93
%
Other borrowings
2,811,435
3,493
0.49
%
2,896,477
16,538
2.27
%
Subordinated notes
282,343
4,191
5.91
%
281,979
4,191
5.90
%
Trust preferred subordinated debentures
113,406
648
2.28
%
113,406
1,237
4.33
%
Total interest-bearing liabilities
23,113,560
36,162
0.62
%
19,907,279
102,933
2.05
%
Demand deposits
12,202,065
9,992,406
Other liabilities
314,500
264,506
Stockholders’ equity
2,791,451
2,722,421
Total liabilities and stockholders’ equity
$
38,421,576
$
32,886,612
Net interest income(2)
$
208,421
$
253,768
Net interest margin
2.22
%
3.16
%
Net interest spread
1.98
%
2.39
%
Loan spread(3)
3.33
%
3.48
%
(1)
The loan averages include non-accrual loans and are stated net of unearned income.
(2)
Taxable equivalent rates used where applicable.
(3)
Yield on loans, net of reserves, less funding cost including all deposits and borrowed funds.
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Nine months ended September 30, 2020
Nine months ended September 30, 2019
(in thousands except percentages)
Average
Balance
Revenue/
Expense
Yield/
Rate
Average
Balance
Revenue/
Expense
Yield/
Rate
Assets
Investment securities – taxable
$
203,437
$
2,364
1.55
%
$
36,452
$
918
3.37
%
Investment securities – non-taxable(2)
194,049
6,983
4.81
%
169,163
6,479
5.12
%
Federal funds sold and securities purchased under resale agreements
151,892
692
0.61
%
64,384
1,090
2.26
%
Interest-bearing deposits in other banks
9,265,177
24,777
0.36
%
2,841,699
48,540
2.28
%
Loans held for sale
1,350,581
33,894
3.35
%
2,392,404
79,116
4.42
%
Loans held for investment, mortgage finance
8,267,307
206,306
3.33
%
6,705,960
178,551
3.56
%
Loans held for investment(1)(2)
16,632,017
529,981
4.26
%
16,849,987
717,541
5.69
%
Less reserve for loan losses
234,587
—
—
203,968
—
—
Loans held for investment, net
24,664,737
736,287
3.99
%
23,351,979
896,092
5.13
%
Total earning assets
35,829,873
804,997
3.00
%
28,856,081
1,032,235
4.78
%
Cash and other assets
1,030,076
945,623
Total assets
$
36,859,949
$
29,801,704
Liabilities and Stockholders’ Equity
Transaction deposits
$
3,991,908
$
26,232
0.88
%
$
3,440,245
$
52,480
2.04
%
Savings deposits
12,133,598
62,279
0.69
%
9,332,059
128,253
1.84
%
Time deposits
3,039,619
33,787
1.48
%
2,317,339
41,817
2.41
%
Total interest-bearing deposits
19,165,125
122,298
0.85
%
15,089,643
222,550
1.97
%
Other borrowings
3,146,756
18,489
0.78
%
3,110,761
57,234
2.46
%
Subordinated notes
282,253
12,573
5.95
%
281,890
12,573
5.96
%
Trust preferred subordinated debentures
113,406
2,573
3.03
%
113,406
3,863
4.55
%
Total interest-bearing liabilities
22,707,540
155,933
0.92
%
18,595,700
296,220
2.13
%
Demand deposits
11,028,119
8,333,719
Other liabilities
293,101
236,136
Stockholders’ equity
2,831,189
2,636,148
Total liabilities and stockholders’ equity
$
36,859,949
$
29,801,704
Net interest income(2)
$
649,064
$
736,015
Net interest margin
2.42
%
3.41
%
Net interest spread
2.08
%
2.65
%
Loan spread(3)
3.39
%
3.65
%
(1)
The loan averages include non-accrual loans and are stated net of unearned income.
(2)
Taxable equivalent rates used where applicable.
(3)
Yield on loans, net of reserves, less funding cost including all deposits and borrowed funds.
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Volume/Rate Analysis
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 September 30, 2020/2019
Nine months ended September 30, 2020/2019
Net
Change
Change due to(1)
Net
Change
Change Due To(1)
(in thousands)
Volume
Yield/Rate(2)
Volume
Yield/Rate(2)
Interest income:
Investment securities
$
1,307
$
5,628
$
(4,321
)
$
1,950
$
6,817
$
(4,867
)
Loans held for sale
(22,339
)
(20,637
)
(1,702
)
(45,222
)
(31,939
)
(13,283
)
Loans held for investment, mortgage finance loans
7,804
7,994
(190
)
27,755
42,770
(15,015
)
Loans held for investment
(78,327
)
(8,577
)
(69,750
)
(187,560
)
(9,085
)
(178,475
)
Federal funds sold and securities purchased under resale agreements
(553
)
(487
)
(66
)
(398
)
1,523
(1,921
)
Interest-bearing deposits in other banks
(20,010
)
37,438
(57,448
)
(23,763
)
111,280
(135,043
)
Total
(112,118
)
21,359
(133,477
)
(227,238
)
121,366
(348,604
)
Interest expense:
Transaction deposits
(11,790
)
3,587
(15,377
)
(26,248
)
8,411
(34,659
)
Savings deposits
(32,778
)
10,832
(43,610
)
(65,974
)
38,657
(104,631
)
Time deposits
(8,569
)
860
(9,429
)
(8,030
)
12,891
(20,921
)
Other borrowings
(13,045
)
(487
)
(12,558
)
(38,745
)
820
(39,565
)
Long-term debt
(589
)
5
(594
)
(1,290
)
15
(1,305
)
Total
(66,771
)
14,797
(81,568
)
(140,287
)
60,794
(201,081
)
Net interest income
$
(45,347
)
$
6,562
$
(51,909
)
$
(86,951
)
$
60,572
$
(147,523
)
(1)
Yield/rate and volume variances are allocated to yield/rate.
(2)
Taxable equivalent rates used where applicable assuming a 21% tax rate.
Net Interest Income
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 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 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.
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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 0.38% 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 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 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 0.57% for the nine months ended September 30, 2020 , compared to 1.34% for the same period in 2019 .
Non-interest Income
Three months ended September 30,
Nine months ended September 30,
(in thousands)
2020
2019
2020
2019
Service charges on deposit accounts
$
2,864
$
2,707
$
8,616
$
8,535
Wealth management and trust fee income
2,502
2,330
7,317
6,468
Brokered loan fees
15,034
8,691
33,813
21,093
Servicing income
7,329
3,549
18,195
9,409
Swap fees
484
1,196
4,709
2,828
Net gain/(loss) on sale of loans held for sale
25,242
(6,011
)
51,265
(12,502
)
Other(1)
6,893
7,839
18,715
38,848
Total non-interest income
$
60,348
$
20,301
$
142,630
$
74,679
(1)
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 $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
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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. 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 September 30,
Nine months ended September 30,
(in thousands)
2020
2019
2020
2019
Salaries and employee benefits
$
84,096
$
80,722
$
262,080
$
238,235
Net occupancy expense
8,736
8,125
26,582
23,914
Marketing
3,636
14,753
20,146
40,548
Legal and professional
11,207
11,394
40,003
31,428
Communications and technology
31,098
10,805
87,649
31,025
FDIC insurance assessment
6,374
5,220
19,363
14,480
Servicing-related expenses
12,287
8,165
48,758
19,613
Merger-related expenses
—
—
17,756
—
Other(1)
8,307
10,245
31,173
33,420
Total non-interest expense
$
165,741
$
149,429
$
553,510
$
432,663
(1)
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 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. 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.
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Analysis of Financial Condition
Loans Held for Investment
The following table summarizes our loans held for investment on a gross basis by portfolio segment:
September 30, 2020
December 31, 2019
(in thousands)
Commercial
$
8,786,917
$
9,133,444
Energy
968,993
1,425,309
Mortgage finance
9,378,104
8,169,849
Real estate
6,112,672
6,008,040
Gross loans held for investment
$
25,246,686
$
24,736,642
Deferred income (net of direct origination costs)
(78,624
)
$
(90,380
)
Allowance for credit losses on loans
(290,165
)
$
(195,047
)
Total loans held for investment, net
$
24,877,897
$
24,451,215
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 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 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 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 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. We also make loans to customers that are secured by assets located outside of Texas. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for credit losses.
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Non-performing Assets
Non-performing assets include non-accrual loans and leases and repossessed assets. The table below summarizes our non-performing assets by type and by type of property securing the credit:
(in thousands)
September 30, 2020
December 31, 2019
September 30, 2019
Non-accrual loans(1)
Commercial
Assets of the borrowers
$
35,829
$
57,901
$
21,975
Inventory
15,266
26,426
18,133
Other
11,416
4,308
6,013
Total commercial
62,511
88,635
46,121
Energy
Oil and gas properties
73,811
125,049
63,189
Total energy
73,811
125,049
63,189
Real estate
Assets of the borrowers
14,663
—
—
Commercial property
5,437
1,751
1,167
Single family residences
218
1,449
1,452
Other
5,306
8,500
8,757
Total real estate
25,624
11,700
11,376
Total non-performing assets
$
161,946
$
225,384
$
120,686
Restructured loans - accruing
$
—
$
—
$
—
Loans held for investment past due 90 days and accruing(2)
$
15,896
$
17,584
$
29,648
Loans held for sale past due 90 days and accruing(3)
$
15,631
$
8,207
$
9,187
(1)
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.
(2)
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.
(3)
Includes loans guaranteed by U.S. government agencies that were repurchased out of Ginnie Mae securities. Loans are recorded as loans held for sale and carried at fair value on the balance sheet. Interest on these past due loans accrues at the debenture rate guaranteed by the U.S. government. 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 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 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
The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the allowance for credit losses at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. We adopted ASU 2016-13 on January 1, 2020, which replaced the incurred loss methodology for determining our provision for credit losses and allowance for credit losses with the Current Expected Credit Loss ("CECL") model. 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 $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
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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:
Nine months ended September 30, 2020
Year ended December 31, 2019
Nine months ended September 30, 2019
(in thousands except percentage and multiple data)
Allowance for credit losses on loans:
Beginning balance
$
195,047
$
191,522
$
191,522
Impact of CECL adoption
8,585
—
—
Loans charged-off:
Commercial
35,376
44,837
30,869
Energy
100,239
32,625
31,828
Real estate
—
177
177
Total charge-offs
135,615
77,639
62,874
Recoveries:
Commercial
883
3,054
1,300
Energy
1,303
316
107
Total recoveries
2,186
3,370
1,407
Net charge-offs
133,429
74,269
61,467
Provision for credit losses on loans
219,962
77,794
60,083
Ending balance
$
290,165
$
195,047
$
190,138
Allowance for off-balance sheet credit losses:
Beginning balance
$
8,640
$
11,434
$
11,434
Impact of CECL adoption
563
—
—
Provision for off-balance sheet credit losses
6,038
(2,794
)
(2,083
)
Ending balance
$
15,241
$
8,640
$
9,351
Total allowance for credit losses
$
305,406
$
203,687
$
199,489
Total provision for credit losses
$
226,000
$
75,000
$
58,000
Allowance for credit losses on loans to LHI
1.15
%
0.79
%
0.77
%
Net charge-offs to average LHI
0.72
%
0.31
%
0.35
%
Total provision for credit losses to average LHI
1.21
%
0.32
%
0.33
%
Recoveries to total charge-offs
1.61
%
4.34
%
2.24
%
Allowance for off-balance sheet credit losses to off-balance sheet credit commitments
0.18
%
0.10
%
0.11
%
Combined allowance for credit losses to LHI
1.21
%
0.83
%
0.81
%
Allowance as a multiple of non-performing loans
1.8
x
0.9
x
1.6
x
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
Through our MCA program we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to Ginnie Mae and GSEs such as Fannie Mae and Freddie Mac. For additional information on our loans held for sale portfolio, see Note 5 - Certain Transfers of Financial Assets in the accompanying notes to the consolidated financial statements included elsewhere in this report.
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Table of Contents
Liquidity and Capital Resources
In general terms, liquidity is a measurement of our ability to meet our cash needs. Our objectives in managing our liquidity are to maintain our ability to meet loan commitments, repurchase investment securities or repay deposits and other liabilities in accordance with their terms, without an adverse impact on our current or future earnings. Our liquidity strategy is guided by policies, formulated and monitored by our senior management and our Asset and Liability Management Committee (“ALCO”), which take into account the demonstrated marketability of our assets, the sources and stability of our funding and the level of unfunded commitments. 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 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, 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)
September 30, 2020
December 31, 2019
September 30, 2019
Federal funds sold and securities purchased under resale agreements
$
—
$
30,000
$
25,000
Interest-bearing deposits
10,461,544
4,233,766
4,968,185
Total liquidity assets
$
10,461,544
$
4,263,766
$
4,993,185
Total liquidity assets as a percent of:
Total loans held for investment
42.1
%
17.3
%
20.2
%
Total earning assets
28.0
%
13.5
%
15.4
%
Total deposits
32.7
%
16.1
%
18.2
%
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. These deposits are generated principally through development of long-term customer relationships, with a significant focus on treasury management products. In addition to deposits from our core customers, we also have access to deposits through brokered customer relationships. For regulatory purposes, these relationship brokered deposits are categorized as brokered deposits; however, since these deposits arise from a customer relationship, which involves extensive treasury services, we consider these deposits to be core deposits for our reporting purposes.
We also have access to incremental deposits through brokered retail certificates of deposit, or CDs. These traditional brokered deposits are generally of short maturities and are used to fund temporary differences in the growth in loan balances, including growth in loans held for sale or other specific categories of loans as compared to customer deposits. The following table summarizes our period-end and average core customer deposits, relationship brokered deposits and traditional brokered deposits:
(in thousands)
September 30, 2020
December 31, 2019
September 30, 2019
Deposits from core customers
$
27,339,283
$
22,549,568
$
22,885,756
Deposits from core customers as a percent of total deposits
85.5
%
85.2
%
83.5
%
Relationship brokered deposits
$
2,295,530
$
1,617,247
$
2,430,543
Relationship brokered deposits as a percent of average total deposits
7.2
%
6.1
%
8.9
%
Traditional brokered deposits
$
2,324,674
$
2,311,778
$
2,097,004
Traditional brokered deposits as a percent of total deposits
7.3
%
8.7
%
7.6
%
Average deposits from core customers(1)
$
25,580,278
$
20,747,292
$
19,431,375
Average deposits from core customers as a percent of average total deposits
84.7
%
84.1
%
82.9
%
Average relationship brokered deposits(1)
$
2,078,708
$
2,096,287
$
2,190,618
Average relationship brokered deposits as a percent of average total deposits
6.9
%
8.5
%
9.4
%
Average traditional brokered deposits(1)
$
2,534,258
$
1,813,037
$
1,801,369
Average traditional brokered deposits as a percent of average total deposits
8.4
%
7.4
%
7.7
%
(1) Annual averages presented for December 31, 2019 .
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We have access to sources of traditional brokered deposits that we estimate to be $7.5 billion . Based on our internal guidelines, we have chosen to limit our use of these sources to a lesser amount. We have increased our use of traditional brokered deposits in 2019 and 2020 in response to favorable rates available in that market relative to other available funding sources.
We have short-term borrowing sources available to supplement deposits and meet our funding needs. Such borrowings are generally used to fund our mortgage finance loans, due to their liquidity, short duration and interest spreads available. These borrowing sources include federal funds purchased from our downstream correspondent bank relationships (which consist of banks that are smaller than our Bank) and from our upstream correspondent bank relationships (which consist of banks that are larger than our Bank), customer repurchase agreements and advances from the FHLB and the Federal Reserve. The following table summarizes our short-term and other borrowings:
(in thousands)
September 30, 2020
Federal funds purchased
$
202,605
Repurchase agreements
5,578
FHLB borrowings
2,700,000
Line of credit
—
Total short-term borrowings
$
2,908,183
Maximum short-term borrowings outstanding at any month-end during 2020
$
5,195,267
The following table summarizes our other borrowing capacities net of balances outstanding. As of September 30, 2020 , all are scheduled to mature within one year.
(in thousands)
September 30, 2020
FHLB borrowing capacity relating to loans
$
7,987,126
FHLB borrowing capacity relating to securities
1,118,321
Total FHLB borrowing capacity(1)
$
9,105,447
Unused federal funds lines available from commercial banks
$
975,000
Unused Federal Reserve borrowings capacity
$
2,230,000
Unused revolving line of credit(2)
$
130,000
(1)
FHLB borrowings are collateralized by a blanket floating lien on certain real estate secured loans, mortgage finance assets and also certain pledged securities.
(2)
Unsecured revolving, non-amortizing line of credit with maturity date of December 15, 2020. Proceeds may be used for general corporate purposes, including funding regulatory capital infusions into the Bank. The loan agreement contains customary financial covenants and restrictions. 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.
For additional information regarding our capital and stockholders' equity, see Note 7 - Regulatory Restrictions in the accompanying notes to the consolidated financial statements included elsewhere in this report.
Commitments and Contractual Obligations
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.
(in thousands)
Within One
Year
After One But
Within Three
Years
After Three
But Within
Five Years
After
Five
Years
Total
Deposits without a stated maturity
$
29,142,214
$
—
$
—
$
—
$
29,142,214
Time deposits
1,769,116
1,043,127
5,024
6
2,817,273
Federal funds purchased and customer repurchase agreements
208,183
—
—
—
208,183
FHLB borrowings
2,700,000
—
—
—
2,700,000
Subordinated notes
—
—
—
282,400
282,400
Trust preferred subordinated debentures
—
—
—
113,406
113,406
Total contractual obligations
$
33,819,513
$
1,043,127
$
5,024
$
395,812
$
35,263,476
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Critical Accounting Policies
SEC guidance requires disclosure of “critical accounting policies.” The SEC defines “critical accounting policies” as those that are most important to the presentation of a company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States. The more significant of these policies are summarized in Note 1 - Operations and Summary of Significant Accounting Policies in the notes to the consolidated financial statements included elsewhere in this report and in our 2019 Form 10-K. Not all significant accounting policies require management to make difficult, subjective or complex judgments. However, the policy noted below could be deemed to meet the SEC’s definition of a critical accounting policy.
Allowance for Credit Losses
Management considers the policies related to the allowance for credit losses as the most critical to the financial statement presentation. The total allowance for credit losses includes activity related to allowances calculated in accordance with Accounting Standards Codification (“ASC”) 326, Credit Losses . The allowance for credit losses is established through a provision for credit losses charged to current earnings. The amount maintained in the allowance reflects management’s continuing evaluation of the loan losses expected to be recognized over the life of the loans in our portfolio. The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. For purposes of determining the allowance for credit losses, the loan portfolio is segregated by product types in order to recognize differing risk profiles among categories, and then further segregated by credit grades. Loans that do not share risk characteristics are evaluated on an individual basis and are not included in the collective evaluation. Management estimates the allowance balance using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts. Adjustments to historical loss information are made to incorporate our reasonable and supportable forecast of future losses at the portfolio segment level, as well as any necessary qualitative adjustments using a Portfolio Level Qualitative Factor ("PLQF") and/or a Portfolio Segment Level Qualitative Factor ("SLQF"). The PLQF and SLQF are utilized to address factors that are not present in historical loss rates and are otherwise unaccounted for in the quantitative process. A reserve is recorded upon origination or purchase of a loan. See “Summary of Credit Loss Experience” above and Note 4 – Loans Held for Investment and Allowance for Credit Losses on Loans in the accompanying notes to the consolidated financial statements included elsewhere in this report for further discussion of the risk factors considered by management in establishing the allowance for credit losses.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.