What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-02-09 compared with 2020-02-12 · 272 added, 213 removed, 399 unchanged (55% of the section changed)

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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.

Certain statements and financial analysis contained in this report that are not historical facts may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995.

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 and constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995.

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, statements related to the proposed merger, including the expected timing of the consummation of the merger, the potential effects of the proposed merger on our business and operations upon or prior to the consummation thereof, the effects on us if the merger is not consummated and information regarding the combined business and operations of TCBI and IBTX following the merger, if consummated, 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 financial impact of the Tax Act on our results of operations, 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 loan losses and provision for loan 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 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 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.

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• 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 possibility that the previously announced merger does not close when expected or at all because required regulatory, stockholder or other approvals and other conditions to closing are not received or satisfied on a timely basis or at all.

The possibility that the various federal and state regulatory agencies from which approval for the merger must be obtained impose conditions that could adversely affect us or cause the merger to be delayed or abandoned.

The occurrence of any event, change or other circumstance that could give rise to the right of TCBI, IBTX or both to terminate the merger agreement.

The negative impact on our stock price and our future business and financial results if the proposed merger is not consummated.

The inability of our stockholders to be certain of the precise value of the merger consideration they may receive in the merger due to the fluctuation in the market price of IBTX and TCBI common stock, including as a result of the financial performance of TCBI prior to closing.

The dilution caused by IBTX's issuance of additional shares of its capital stock in connection with the proposed merger.

The outcome of pending or threatened litigation or of matters before regulatory agencies, whether currently existing or commencing in the future, including litigation related to the proposed merger.

The possibility that the anticipated benefits of the proposed merger, including anticipated cost savings and strategic gains, are not realized when expected or at all, including as a result of the impact of, or problems arising from, the integration of the two companies or as a result of the strength of the economy, competitive factors in the areas where we and IBTX do business, or as a result of other unexpected factors or events.

The possibility that the proposed merger may be more expensive to complete than anticipated, including as a result of unexpected factors or events.

The impact of purchase accounting with respect to the proposed merger, or any change in the assumptions used regarding the assets purchased and liabilities assumed to determine their fair value.

Diversion of management's attention from ongoing business operations and opportunities as a result of the proposed merger.

Potential adverse reactions or changes to business or employee relationships, including those resulting from the announcement or completion of the proposed merger.

The ability to complete the transaction and integration of TCBI and IBTX successfully, which may take longer than anticipated or be more costly than anticipated or have unanticipated adverse results relating to TCBI's or IBTX's existing businesses.

Operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which IBTX and TCBI are highly dependent.

Changes in interest rates, which may affect TCBI's or IBTX's net income and other future cash flows, or the market value of TCBI's or IBTX's assets, including the market value of investment securities.

Changes in the ability of TCBI or IBTX to access the capital markets, including changes in their respective credit ratings.

• 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.

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• 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 loan 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 loan losses as a result of the implementation of CECL.

• 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.

• 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.

• 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 Act 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.

• 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.

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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.

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.

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.

• The failure to manage information systems risk or to prevent cyber-incidents against us, our customers or our third party vendors, or to manage risks from failures, 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 costs and effects of cyber-incidents or other failures, disruptions or security breaches of our systems or those our third-party providers.

• 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.

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Department of Treasury and the Federal Reserve.

• The effect of changes in laws, regulations, policies and guidelines (including, among others, laws, regulations, policies and guidelines concerning taxes, banking, securities and monetary and fiscal policies) with which we and our subsidiaries must comply under the new Biden Administration and the effects of any such changes on our business and results of operations;

• 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.

• The failure to identify, attract and retain key personnel or the loss of key individuals or groups of employees.

• Increased or more effective competition from banks and other financial service providers in our markets.

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• 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.

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• 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 and related matters with respect to the financial services industry, including those directly involving us or our Bank.

• 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.

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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.

Additional Information about the Merger and Where to Find It

In connection with the proposed merger between IBTX and TCBI, IBTX filed a registration statement on Form S-4 with the SEC on January 21, 2020 to register the shares of IBTX’s capital stock to be issued in connection with the merger.

The registration statement includes a joint proxy statement/prospectus.

The registration statement has not yet become effective.

After the Form S-4 is effective, a definitive joint proxy statement/prospectus will be sent to the stockholders of IBTX and TCBI seeking their approval of the proposed transaction.

INVESTORS AND SECURITY HOLDERS ARE URGED TO READ THE REGISTRATION STATEMENT ON FORM S-4, THE JOINT PROXY STATEMENT/PROSPECTUS INCLUDED WITHIN THE REGISTRATION STATEMENT ON FORM S-4 AND ANY OTHER RELEVANT DOCUMENTS FILED OR TO BE FILED WITH THE SEC IN CONNECTION WITH THE PROPOSED TRANSACTION BECAUSE THESE DOCUMENTS DO AND WILL CONTAIN IMPORTANT INFORMATION ABOUT IBTX, TCBI AND THE PROPOSED TRANSACTION.

Investors and security holders may obtain copies of these documents free of charge through the website maintained by the SEC at www.sec.gov or from IBTX at its website, www.ibtx.com, or from TCBI at its website, www.texascapitalbank.com.

Documents filed with the SEC by IBTX will be available free of charge by accessing the Investor Relations page of IBTX’s website at www.ibtx.com or, alternatively, by directing a request by telephone or mail to Independent Bank Group, Inc., 7777 Henneman Way, McKinney, Texas 75070, (972) 562-9004, and documents filed with the SEC by TCBI will be available free of charge by accessing TCBI’s website at www.texascapitalbank.com under the tab “About Us,” and then under the heading “Investor Relations” or, alternatively, by directing a request by telephone or mail to Texas Capital Bancshares, Inc., 2000 McKinney Avenue, Suite 700, Dallas, Texas 75201, (214) 932-6600.

Participants in the Solicitation

TCBI, IBTX and certain of their respective directors and executive officers may be deemed to be participants in the solicitation of proxies from the stockholders of TCBI and IBTX in connection with the proposed transaction under the rules of the SEC.

Certain information regarding the interests of these participants and a description of their direct and indirect interests, by security holdings or otherwise, will be included in the joint proxy statement/prospectus regarding the proposed transaction when it becomes available.

Additional information about IBTX, and its directors and executive officers, may be found in IBTX’s definitive proxy statement relating to its 2019 Annual Meeting of Shareholders filed with the SEC on April 23, 2019, and other documents filed by IBTX with the SEC.

Additional information about TCBI, and its directors and executive officers, may be found in TCBI’s definitive proxy statement relating to its 2019 Annual Meeting of Shareholders filed with the SEC on March 7, 2019, and other documents filed by TCBI with the SEC.

These documents can be obtained free of charge from the sources described above.

Overview of Our Business Operations

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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 IBTX announced that both companies' boards of directors unanimously approved the merger agreement to combine the companies in an all-stock merger of equals.

Upon closing of the merger, each share of TCBI common stock will be exchanged for 1.0311 shares of IBTX common stock.

The corporate headquarters of the surviving entity and the surviving bank will be located in McKinney, Texas.

The name of the surviving entity will be Independent Bank Group, Inc., and the name of the surviving bank will be Texas Capital Bank.

The surviving bank will be operated under the name Independent Financial in Colorado and under the name Texas Capital Bank in Texas.

The board of directors of the surviving entity and the surviving bank will be comprised of 13 directors, of which seven will be former members of the Board of Directors of TCBI and six will be former members of the board of directors of IBTX.

The merger is expected to close in mid-2020, subject to satisfaction of customary closing conditions, including receipt of customary regulatory approvals and approval by the stockholders of each company.

Refer to Merger with Independent Bank Group, Inc.

in Item 1 for additional disclosures.

On December 9, 2019, we and IBTX entered into the 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.

While these expenses, as well as merger-related expenses incurred in the first half of 2020, 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.

During the fourth quarter of 2020, we did experience improvements in non-interest expense as a result of these actions, specifically in salaries and employee benefits due to the workforce reduction and in communications and technology expense related to lower software amortization expense as compared to the third quarter of 2020.

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.

Impact of COVID-19 Pandemic

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 December 31, 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 into the first quarter of 2021, 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 recognize that these industries may take longer to recover as consumers may be hesitant to return to full social interaction or may change their spending habits on a more permanent basis as a result of the pandemic.

We continue to monitor these customers closely.

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 in 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 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, a majority 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, but will begin transitioning employees back into the office in a phased approach when it is safe to do so.

When the time comes 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 $766.2 million, or 3% of total loans held for investment, at December 31, 2020, compared to $1.4 billion, or 6% of total loans, at December 31, 2019.

The decline in outstanding energy loans is due to our strategic de-risking of the energy portfolio as well as a heightened level of charge-offs in 2020 as we reached final resolution on a number of loans previously disclosed as problem loans.

At December 31, 2020, energy non-accruals decreased to $51.7 million, compared to $125.0 million at December 31, 2019, further evidencing final resolution of previously disclosed problem loans.

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 December 31, 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 December 31, 2020 approximately 40% of our exposure was located in lower cost production areas such as the Permian Basin and Eagle Ford.

Year ended December 31, 2020 compared to year ended December 31, 2019

We reported net income of $322.9 million and net income available to common stockholders of $313.1 million , or $6.21 per diluted common share, for the year ended December 31, 2019 , compared to net income of $300.8 million and net income available to common stockholders of $291.1 million , or $5.79 per diluted common share, for 2018 .

We reported net income of $66.3 million and net income available to common stockholders of $56.5 million, or $1.12 per diluted common share, for the year ended December 31, 2020, compared to net income of $312.0 million and net income

available to common stockholders of $302.3 million, or $5.99 per diluted common share, for 2019.

Return on average common equity ("ROE") was 2.10% and return on average assets ("ROA") was 0.18% for the year ended December 31, 2020, compared to 11.95% and 1.01%, respectively, for 2019.

The decreases in ROE and ROA were driven primarily by larger balances in total mortgage finance loans and liquidity assets.

The decline in net income, ROE and ROA for the year ended December 31, 2020 resulted primarily from a $183.0 million increase in the provision for credit losses, as well as a $103.5 million increase in non-interest expense, driven by the significant year-to-date 2020 expenses described below.

Consolidated Daily Average Balances, Average Yields and Rates

Year ended December 31,

(in thousands except percentages)

2020 2019 2018

(in thousands except percentages) Average

Balance Revenue /

Expense Yield /

Balance Revenue /

Expense Yield /

Balance Revenue /

Expense Yield /

Investment Securities—taxable

$ 689,590 $ 10,112 1.47 % $ 37,574 $ 1,611 4.29 % $ 24,142 $ 849 3.52 %

Investment Securities—non-taxable(2)

195,741 9,320 4.76 % 176,328 8,915 5.06 % 46,553 2,512 5.40 %

Federal funds sold and securities purchased under resale agreements

114,141 693 0.61 % 73,946 1,529 2.07 % 201,236 3,792 1.88 %

Interest-bearing Deposits in other banks

9,653,129 27,569 0.29 % 3,483,254 71,093 2.04 % 1,769,074 32,597 1.84 %

Loans held for sale 1,114,311 36,369 3.26 % 2,688,677 112,526 4.19 % 1,561,530 71,240 4.56 %

Loans held for investment, mortgage finance

8,589,762 285,212 3.32 % 6,999,585 241,665 3.45 % 4,875,860 181,438 3.72 %

Loans held for investment(1)(2)

16,377,733 691,731 4.22 % 16,803,930 934,228 5.56 % 16,075,007 877,688 5.46 %

Less reserve for loan losses

248,563 — — 200,283 — — 183,863 — —

Loans held for investment, net

24,718,932 976,943 3.95 % 23,603,232 1,175,893 4.98 % 20,767,004 1,059,126 5.10 %

Total earning assets 36,485,844 1,061,006 2.91 % 30,063,011 1,371,567 4.56 % 24,369,539 1,170,116 4.80 %

Cash and other assets 1,030,357 952,994 828,150

Total assets $ 37,516,201 $ 31,016,005 $ 25,197,689

Liabilities and stockholders’ equity

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Total interest-bearing deposits

19,305,074 146,117 0.76 % 15,667,512 293,537 1.87 % 12,323,299 185,116 1.50 %

Other borrowings 3,115,416 22,006 0.71 % 3,038,095 70,265 2.31 % 2,102,404 42,738 2.03 %

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Trust preferred subordinated debentures

113,406 3,199 2.82 % 113,406 5,026 4.43 % 113,406 4,715 4.16 %

Total interest-bearing liabilities

22,816,195 188,086 0.82 % 19,100,949 385,592 2.02 % 14,820,683 249,333 1.68 %

Demand deposits 11,567,549 8,989,104 7,890,304

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Total liabilities and stockholders’ equity

$ 37,516,201 $ 31,016,005 $ 25,197,689

Net interest income(2) $ 872,920 $ 985,975 $ 920,783

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Years Ended December 31,

Change Due To(1)

(in thousands)

Yield/Rate(2)

2020/2019 2019/2018

Change Change Due To(1) Net

Change Change Due To(1)

(in thousands) Volume Yield/Rate(2) Volume Yield/Rate(2)

Interest income:

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Interest-bearing deposits in other banks (43,524) 133,964 (177,488) 38,496 36,304 2,192

Total (310,561) 141,435 (451,996) 201,451 208,851 (7,400)

Interest expense:

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Long-term debt (1,827) 20 (1,847) 311 20 291

Total (197,506) 70,442 (267,948) 136,259 69,059 67,200

Net interest income $ (113,055) $ 70,993 $ (184,048) $ 65,192 $ 139,792 $ (74,600)

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Net interest income was $868.8 million for the year ended December 31, 2020 compared to $979.7 million for 2019.

The increase was primarily due to an increase in average earning assets of $5.7 billion , offset by the effect of decreases in interest rates on loan yields, an increase in average interest-bearing liabilities of $4.3 billion and the effect of increasing funding costs.

The increase in average earning assets included a $1.1 billion increase in average loans held for sale, a $2.8 billion increase in average net loans held for investment, primarily from increases in average mortgage finance loans driven by lower long-term interest rates, a $143.2 million increase in average investment securities, and a $1.6 billion increase in average liquidity assets.

The increase in average interest-bearing liabilities included a $3.3 billion increase in interest-bearing deposits and a $935.7 million increase in other borrowings.

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

Average earning assets for the year ended December 31, 2020 increased by $6.4 billion compared to the same period in 2019, and included a $671.4 million increase in average total investment securities, reflecting the deployment of excess liquidity into higher-yielding investment securities, a $1.1 billion 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 $6.2 billion increase in average liquidity assets, partially offset by a $1.6 billion decrease in average loans held for sale.

The increase in average liquidity assets was the result of actions taken by management during 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 year ended December 31, 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 $3.7 billion for the year ended December 31, 2020 compared to the same period in 2019, primarily due to a $3.6 billion increase in average interest-bearing deposits.

Average demand deposits for the year ended December 31, 2020 increased to $11.6 billion from $9.0 billion for 2019.

Net interest margin for the year ended December 31, 2020 was 2.39% compared to 3.28% for 2019.

The decrease was primarily due to the effect of decreases in interest rates during 2019 on loan yields and higher funding costs compared to 2018 .

The decrease was primarily due to the effect of declining interest rates on earning asset yields and a shift in earning asset composition, primarily increases in lower-yielding liquidity assets and mortgage finance loans coupled with a decline in loans held for investment, excluding mortgage finance, partially offset by lower funding costs compared to 2019.

The yield on total loans held for investment decreased to 3.95% for the year ended December 31, 2020 compared to 4.98% for 2019 and the yield on earning assets decreased to 2.91% for the year ended December 31, 2020 compared to 4.56% for 2019.

The average cost of total deposits and borrowed funds increased to 1.31% for 2019 from 1.02% for 2018 .

The spread on total earning assets, net of the cost of deposits and borrowed funds, was 3.25% for 2019 compared to 3.78% for 2018 .

The decrease was primarily a result of an increase in the cost of interest-bearing liabilities coupled with declining loan yields.

Total funding costs, including all deposits, long-term debt and stockholders' equity increased to 1.25% for 2019 compared to 0.99% for 2018 .

The average cost of total deposits decreased to 0.47% for 2020 from 1.19% for 2019 and total funding costs, including all deposits, long-term debt and stockholders' equity decreased to 0.51% for 2020 compared to 1.25% for 2019.

Non-interest Income

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Servicing income 27,029 13,439 18,307

Swap fees 5,182 4,387 5,625

Net gain/(loss) on sale of loans held for sale 58,026 (20,259) (15,934)

Other(1) 27,238 45,005 26,559

Total non-interest income $ 185,516 $ 92,440 $ 78,024

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Non-interest income increased by $93.1 million during the year ended December 31, 2020 to $185.5 million, compared to $92.4 million for 2019.

Other non-interest income increased $18.4 million, which included the settlement of $15.0 million in legal claims during 2019.

Brokered loan fees increased $7.2 million due to an increase in total mortgage finance volumes during 2019 compared to 2018.

Offsetting these increases was a $4.9 million decrease in servicing income due to an overall decrease in average MSR balances held during 2019 as compared to 2018, a $4.3 million decrease in net gain/(loss) on sale of loans held for sale, a $1.5 million decrease in service charges and a $1.2 million decrease in swap fees.

Swap fees are based upon customer swap transactions, are received from the institution that is our counterparty on the transaction and fluctuate from time to time based on the number and volume of transactions closed during the year.

This increase was primarily due to a $78.3 million increase in net gain/(loss) on sale of loans held for sale, a $16.7 million increase in brokered loan fees and a $13.4 million increase in servicing income, partially offset by a $17.8 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, which was offset by the decline in net interest income on loans held for sale noted above.

The increase in brokered loans fees was due to an increase in total mortgage finance volumes in 2020, and the increase in servicing income was due to an increase in the outstanding balance of our servicing portfolio.

The decrease in other non-interest income resulted primarily from the settlement of $15.0 million in legal claims in 2019 that did not recur in 2020.

Non-interest Expense

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Net occupancy expense 34,955 32,989 30,342

Marketing 23,581 53,355 39,335

Legal and professional 52,132 52,460 42,990

2 unchanged sentences

Servicing-related expenses 64,625 22,573 14,934

Allowance and other carrying costs for OREO

Merger-related expenses 17,756 1,370 —

Other(2) 41,809 44,701 49,670

Total non-interest expense $ 704,396 $ 600,850 $ 532,533

(1) Values have been adjusted to reflect revisions to certain previously reported financial information.

See “Item 8, Note 1— Operations and Summary of Significant Accounting Policies—Revision of Prior Period Financial Statements ” for additional information.

(2) 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 year ended December 31, 2020 increased $103.5 million compared to 2019.

The increase is primarily due to increases in salaries and employee benefits, net occupancy expense and communication and technology expenses, all of which were due to general business growth and continued build-out, as well as increases in marketing, legal and professional and servicing-related expenses, partially offset by decreases in FDIC insurance assessment and other non-interest expense.

The increase in marketing expense was primarily due to an increase in variable expenses tied to deposit balances.

The increase in legal and professional expense includes $1.3 million in expenses related to our pending merger with IBTX, as well as increases related to investment in Bask Bank and new commercial loan verticals.

The increase in servicing-related expenses is due to higher amortization expense resulting from higher mortgage prepayment rates, as well as an increase in impairment expense.

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

The increase in salaries and employee benefits was primarily due to $18.0 million in severance expense related to our workforce reduction in 2020.

The increase in communications and technology expense was primarily due to $36.0 million in write-offs of certain software assets in 2020 and $5.9 million in technology expense related to the roll-out of our PPP capabilities in 2020.

The full impact on salaries and employee benefits expense from the reduction in workforce and on software amortization included in communications and technology expense from the software write-offs recorded during 2020 is expected to be realized in non-interest expense in the first half of 2021, though we did experience improvements during the fourth quarter of 2020.

The increase in servicing-related expenses was primarily due to higher MSR amortization and impairment expense, resulting primarily from higher mortgage prepayment rates.

Analysis of Financial Condition

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(in thousands) 2020 2019 2018 2017 2016

Commercial $ 8,861,580 $ 9,133,444 $ 9,117,546 $ 8,373,398 $ 6,622,078

Energy 766,217 1,425,309 1,631,371 1,130,000 889,583

Mortgage finance 9,079,409 8,169,849 5,877,524 5,308,160 4,497,338

Equipment leases

Real estate 5,794,624 6,008,040 6,050,083 5,960,785 5,560,909

Total loans held for investment $ 24,501,830 $ 24,736,642 $ 22,676,524 $ 20,772,343 $ 17,569,908

Our total loans held for investment have grown at an annual rate of 9% , 9% and 18% in 2019 , 2018 and 2017 , respectively, with the majority of the growth in 2019 relating to mortgage finance loans.

These 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 33% of total loans held for investment at December 31, 2019 compared to 26% at December 31, 2018.

Total loans held for investment were $24.5 billion at December 31, 2020, a decline of $234.8 million from 2019.

While the majority of our portfolio segments declined in 2020, the balance of mortgage finance loans increased $909.6 million to $9.1 billion at December 31, 2020.

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 37% of total loans held for investment at December 31, 2020 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.

The significant growth in this portfolio during 2020 resulted from increases in volumes driven by continued lower long-term interest rates.

Offsetting this increase was a slight decline in traditional loans held for investment in 2019.

These declines reflect slower loan growth in 2019 as compared to 2018, as well as planned reductions in our leveraged lending and energy balances.

Traditional loans held for investment decreased 7% during 2020.

The majority of the decrease was in our commercial and energy portfolios, and was partially offset by the addition of $617.5 million in PPP loan balances at December 31, 2020.

Throughout 2020 we strategically reduced portfolios that have experienced higher historic losses, primarily energy and leveraged lending.

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

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

As of December 31, 2019 , $26.0 million of our syndicated loans were on non-accrual.

As of December 31, 2020, none of our syndicated loans were on non-accrual.

Portfolio Geographic and Industry Concentrations

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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 loan losses.

The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for credit losses.

The table below summarizes the industry concentrations of our loans held for investment on a gross basis at December 31, 2020.

(in thousands except percentage data)

(in thousands except percentage data) Amount Percent of

Total Loans Held for Investment

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Oil & gas and pipelines 1,020,033 4.2 %

Government and education

Healthcare and pharmaceuticals 460,517 1.9 %

Machinery, equipment and parts manufacturing

Commercial services 459,409 1.9 %

Retail 388,682 1.6 %

Technology, telecom and media 309,532 1.3 %

Machinery, equipment and parts manufacturing 301,167 1.2 %

Materials and commodities 231,609 0.9 %

Entertainment and recreation

Food and beverage manufacturing and wholesale 225,003 0.9 %

Consumer services 222,009 0.9 %

Entertainment and recreation 203,605 0.8 %

Transportation services 172,344 0.7 %

Government and education 145,390 0.6 %

Diversified or miscellaneous 968,154 4.0 %

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Our largest concentration of loans held for investment, excluding mortgage finance, in any single industry is in real estate and construction.

Loans extended to borrowers within the real estate and construction industries generally include market risk real estate loans.

We extend market risk real estate loans, including both construction/development financing and limited term financing, to builders, professional real estate developers and owners/managers of commercial real estate projects and properties who have a demonstrated record of past success with similar properties.

Collateral properties include office buildings, warehouse/distribution buildings, shopping centers, apartment buildings and residential and commercial tract development located primarily within our five major metropolitan markets in Texas.

These loans are generally repaid through the borrower's sale or lease of the properties or through refinancing by other institutional sources offering long-term fixed rate financing.

Loans extended to borrowers within the real estate and construction industries generally include market risk real estate loans, consisting of commercial real estate loans and loans made to residential builders and developers.

Loan amounts are determined in part from an analysis of pro forma cash flows.

Loans are also underwritten to comply with product-type specific advance rates against both cost and market value.

Borrowers represented within the real estate and construction category are largely owners and managers of both residential and non-residential commercial real estate properties, including homebuilders.

We extend commercial real estate loans, including both construction/development financing and limited term financing, to professional real estate developers and owners/managers of commercial real estate projects and properties who have a demonstrated record of past success with similar properties.

Collateral properties include office buildings, warehouse/distribution buildings, shopping centers, hotels/motels, senior living, apartment buildings and residential and commercial tract development.

The primary source of repayment on these loans is expected to come from the sale, permanent financing or lease of the real property collateral.

Loans to residential builders are typically in the form of uncommitted guidance lines and are for the purpose of developing lots into single-family homes, while loans to developers are typically in the form of borrowing base lines extended for the purpose of acquiring and developing raw land into lots that can be further sold to home builders.

Loans extended to borrowers in the financials excluding banks category are comprised largely of loans to companies who loan money to businesses and consumers for various purposes including, but not limited to, insurance, consumer goods and real estate.

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Approximately 98% of our loans held for investment are secured by collateral.

Over 61% of the real estate collateral is located in Texas.

Over 60.3% of the market risk real estate collateral is located in Texas.

The table below sets forth information regarding the distribution of our loans held for investment on a gross basis among various types of collateral at December 31, 2020:

(in thousands except percentage data)

(in thousands except percentage data) Amount Percent of

Total Loans Held for Investment

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Real property 5,794,624 23.6 %

Municipal tax- and revenue-secured

Energy 766,217 3.1 %

Government guaranty 620,919 2.5 %

Other assets 368,633 1.5 %

Highly liquid assets 226,783 0.9 %

Municipal tax- and revenue-secured 186,061 0.8 %

Rolling stock 23,872 0.1 %

Government guaranty

Unsecured 587,276 2.4 %

Total loans held for investment $ 24,501,830 100.0 %

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Property type concentrations are stated as a percentage of year-end total real estate loans as of December 31, 2020:

(in thousands except percentage data)

(in thousands except percentage data) Amount Percent of

Property type:

Apartment buildings

1-4 Family dwellings (other than condominium)

Apartment/condominium buildings 1,195,645 20.8 %

Commercial buildings 597,163 10.3 %

1-4 Family dwellings (other than condominium) 585,267 10.1 %

Senior housing buildings 387,601 6.7 %

Self-storage building 348,442 6.0 %

Hotel/motel buildings 327,327 5.6 %

Hospital/medical buildings

Industrial buildings 314,569 5.4 %

Residential lots 286,981 5.0 %

Shopping center/mall buildings 257,404 4.4 %

Industrial buildings

Commercial lots 75,480 1.3 %

Unimproved land

Other 168,440 2.9 %

Other than market risk

1-4 Family dwellings (other than condominium)

Commercial buildings 350,462 6.0 %

Industrial buildings 358,825 6.2 %

1-4 Family dwellings (other than condominium) 335,562 5.8 %

Other 205,456 3.5 %

Total real estate loans 5,794,624 100 %

The table below summarizes our market risk real estate portfolio at December 31, 2020 as segregated by the geographic region in which the property is located:

(in thousands except percentage data)

(in thousands except percentage data) Amount Percent of

Geographic region:

Dallas/Fort Worth $ 1,040,163 22.9 %

Houston 725,827 16.0 %

San Antonio 428,795 9.4 %

Austin 453,389 10.0 %

Other Texas cities 89,935 2.0 %

Other states 1,806,210 39.7 %

Total market risk real estate loans $ 4,544,319 100.0 %

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Generally, our policy requires a new appraisal every three years.

However, in periods of economic uncertainty where real estate values can fluctuate rapidly, more current appraisals are obtained when warranted by conditions such as a borrower’s deteriorating financial condition, their possible inability to perform on the loan or other indicators of increasing risk of reliance on collateral value as the sole source of repayment of the loan.

However, in periods of economic uncertainty where real estate market conditions may change rapidly, more current appraisals are obtained when warranted by conditions such as a borrower’s deteriorating financial condition, their possible inability to perform on the loan or other indicators of increasing risk of reliance on collateral value as the sole source of repayment of the loan.

Annual appraisals are generally obtained for loans graded substandard or worse where real estate is a material portion of the collateral value and/or the income from the real estate or sale of the real estate is the primary source of debt service.

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The following table provides additional information on our large held for investment credit relationships, excluding mortgage finance, outstanding at year-end:

December 31, 2019

December 31, 2018

Period End Balances

(in thousands, except relationship data)

Relationships

December 31, 2020 December 31, 2019

Period End Balances Period End Balances

(in thousands, except relationship data) Number of

Relationships Committed Outstanding Number of

Relationships Committed Outstanding

$30.0 million and greater 190 $ 8,650,588 $ 4,252,488 177 $ 8,254,124 $ 4,251,321

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The following table summarizes the average committed and outstanding loan balances per relationship related to our large held for investment credit relationships, excluding mortgage finance, at year-end:

2019 Average Balance per Relationship

2018 Average Balance per Relationship

(in thousands)

2020 Average Balance per Relationship 2019 Average Balance per Relationship

(in thousands) Committed Outstanding Committed Outstanding

$30.0 million and greater $ 45,529 $ 22,382 $ 46,633 $ 24,019

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December 31, 2020

(in thousands)

Within 1 Year

After 5 Years

(in thousands) Total Within 1 Year 1-5 Years After 5 Years

Loan maturity:

Commercial $ 8,861,580 $ 3,175,247 $ 5,071,781 $ 614,552

Energy 766,217 241,164 525,053 —

Mortgage finance 9,079,409 9,079,409 — —

Equipment leases

Real estate 5,794,624 1,667,692 3,205,451 921,481

Total loans held for investment $ 24,501,830 $ 14,163,512 $ 8,802,285 $ 1,536,033

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Interest Reserve Loans

As of December 31, 2019 and December 31, 2018 , we had $743.8 million and $718.5 million , respectively, in loans held for investment that included interest reserve arrangements, representing approximately 29% and 34% , respectively, of our construction loans.

As of December 31, 2020 and December 31, 2019, we had $549.1 million and $743.8 million, respectively, in loans held for investment that included interest reserve arrangements, representing approximately 23% and 12%, respectively, of outstanding construction loans, which are a component of real estate loans.

Interest reserve provisions are common in construction loans.

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Non-accrual loans(1)

Oil and gas properties

Assets of the borrowers $ 18,776 $ 57,901 $ 16,538

Accounts receivable and inventory 3,547 26,426 21,300

Other 9,773 4,308 2,548

Total commercial 32,096 88,635 40,386

Oil and gas properties 51,724 125,049 37,532

Total Energy 51,724 125,049 37,532

Assets of the borrowers 14,496 — —

Commercial property 13,569 1,751 988

Hotel/motel 4,619 8,500 —

Single family residences 218 1,449 1,469

Other 5,267 — —

Total real estate 38,169 11,700 2,457

Equipment leases

Total non-accrual loans 121,989 225,384 80,375

OREO(2) — — 79

Total non-performing assets $ 121,989 $ 225,384 $ 80,454

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Loans held for investment past due 90 days and accruing(3) $ 12,541 $ 17,584 $ 9,353

Loans held for sale non-accrual(4) $ 6,966 $ — $ —

Loans held for sale past due 90 days and accruing(5) $ 16,667 $ 8,207 $ 16,829

(1) As of December 31, 2020, 2019 and 2018, non-accrual loans included $45.4 million, $35.1 million and $20.0 million, respectively, in loans that met the criteria for restructured.

At December 31, 2019, 2018 and 2017 , there was no valuation allowance recorded against the OREO balance.

(2) At December 31, 2018, there was no valuation allowance recorded against the OREO balance.

(3) At December 31, 2020, 2019 and 2018, loans past due 90 days and still accruing includes premium finance loans of $6.4 million, $8.5 million and $9.2 million, respectively.

(4) Includes one non-accrual loan previously reported in loans HFI that was transferred to loans HFS as of December 31, 2020 and subsequently sold at carrying value.

(5) 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 December 31, 2019 increased $144.9 million from December 31, 2018 .

The increase during 2019 primarily related to increases in our energy and leveraged loan portfolios.

Energy non-performing assets totaled $125.0 million at December 31, 2019 compared to $37.5 million at December 31, 2018 , and leveraged lending non-performing assets totaled $73.2 million and $28.8 million for the same periods, respectively.

Total non-performing assets at December 31, 2020 decreased $103.4 million from December 31, 2019.

The decrease during 2020 primarily related to charge-offs of energy and leveraged lending loans during 2020.

Non-accrual energy loans totaled $51.7 million (42% of total non-performing assets) at December 31, 2020 compared to $125.0 million (55% of total non-performing assets) at December 31, 2019.

Non-accrual leveraged lending loans totaled $18.9 million (15% of total non-performing assets) at December 31, 2020 compared to $73.2 million (32% of total non-performing assets) at December 31, 2019.

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.

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At December 31, 2020, we had $193.2 million in loans of this type, compared to $46.6 million at December 31, 2019.

Potential problem loan levels have remained elevated throughout 2020 as compared to 2019, primarily as a result of continued economic uncertainty related to the COVID-19 pandemic.

Summary of Loan 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 loan losses at a level consistent with management’s assessment of inherent losses in the loan portfolio at the balance sheet date.

The provision for credit losses, which includes a provision for off-balance sheet credit losses, 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 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 provision for credit losses of $258.0 million for the year ended December 31, 2020, $75.0 million for the year ended December 31, 2019, and $87.0 million for the year ended December 31, 2018.

The decrease in provision recorded during 2019 compared to 2018 was primarily related to decreases in charge-offs and loans held for investment, excluding mortgage finance, balances.

Criticized loans totaled $918.4 million at December 31, 2020, compared to $1.1 billion at September 30, 2020 and $584.1 million at December 31, 2019.

Criticized loan levels have declined in the fourth quarter of 2020 as compared to the third quarter of 2020, however 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 for the past five years:

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(in thousands except percentage and multiple data) 2020 2019 2018 2017 2016

Allowance for loan losses:

Allowance for credit losses:

Beginning balance $ 195,047 $ 191,522 $ 184,655 $ 168,126 $ 141,111

Impact of CECL adoption 8,585 — — — —

Loans charged-off:

Equipment leases

Commercial 73,360 44,352 60,158 13,673 18,843

Energy 133,522 32,625 20,620 20,652 37,762

Real estate 180 662 — 349 528

Total charge-offs 207,062 77,639 80,778 34,674 57,133

Equipment leases

Commercial 1,277 3,054 2,450 4,022 7,702

Energy 6,999 316 489 651 1,760

Real estate — — 69 179 97

Total recoveries 8,276 3,370 3,008 4,852 9,559

Net charge-offs 198,786 74,269 77,770 29,822 47,574

Provision for loan losses

Provision for credit losses on loans 249,769 77,794 84,637 46,351 74,589

Ending balance $ 254,615 $ 195,047 $ 191,522 $ 184,655 $ 168,126

1 unchanged sentence

Beginning balance $ 8,640 $ 11,434 $ 9,071 $ 11,422 $ 9,011

Impact of CECL adoption 563 — — — —

Provision for off-balance sheet credit losses 8,231 (2,794) 2,363 (2,351) 2,411

2 unchanged sentences

Total provision for credit losses $ 258,000 $ 75,000 $ 87,000 $ 44,000 $ 77,000

Allowance for loan losses to LHI

Allowance for credit losses on loans to LHI 1.04 % 0.79 % 0.85 % 0.89 % 0.96 %

Net charge-offs to average LHI 0.80 % 0.31 % 0.37 % 0.16 % 0.29 %

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Allowance for off-balance sheet credit losses to off-balance sheet credit commitments 0.20 % 0.10 % 0.14 % 0.13 % 0.19 %

Combined allowance for credit losses to LHI

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 $203.7 million at December 31, 2019 , $203.0 million at December 31, 2018 and $193.7 million at December 31, 2017 .

The combined allowance as a percentage of loans held for investment decreased to 0.83% at December 31, 2019 from 0.90% and 0.94% at December 31, 2018 and 2017 , respectively.

The downward trend in the combined allowance as a percentage of loans held for investment that began in 2017 continued during 2018 and 2019 due primarily to growth in mortgage finance loans held for investment.

The following table presents a summary of our allowance for loan losses by portfolio segment for the past five years:

Total allowance for credit losses to LHI 1.11 % 0.83 % 0.90 % 0.94 % 1.03 %

Allowance as a multiple of non-performing loans 2.1 x 0.9 x 2.4 x 1.8 x 1.0 x

The allowance for credit losses, including the allowance for off-balance sheet credit losses reported on the consolidated balance sheets in other liabilities, totaled $272.0 million at December 31, 2020, $203.7 million at December 31, 2019 and $203.0 million at December 31, 2018.

The total allowance as a percentage of loans held for investment increased to 1.11% at December 31, 2020 from 0.83% and 0.90% at December 31, 2019 and 2018, respectively.

The total allowance as a percentage of loans held for investment, excluding mortgage finance, increased to 1.77% at December 31, 2020 from 1.24% at December 31, 2019 and 1.22% at December 31, 2018.

The increase in the total allowance as a percentage of loans held for investment at December 31, 2020, compared to December 31, 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 following table presents a summary of our allowance for credit losses on loans by portfolio segment for the past five years:

2020 2019 2018 2017 2016

(in thousands except

percentage data)

Loans Reserve % of

Loan category:

Commercial $ 73,061 36 % $ 102,254 37 % $ 96,814 40 % $ 74,226 40 % $ 77,584 37 %

Energy 84,064 3 % 60,253 6 % 34,882 7 % 48,479 5 % 52,549 5 %

Mortgage finance loans 4,699 37 % 2,265 33 % — 26 % — 26 % — 26 %

Equipment leases

Real estate 92,791 24 % 30,275 24 % 52,595 27 % 53,560 29 % 32,293 32 %

Additional qualitative reserve — — — — 7,231 — 8,390 — 5,700 —

Total allowance for loan losses

During 2019, we refined our methodology for calculating the allowance for loan losses to improve the specificity of the risk weights and the risk-weighting process for each product type assigned to the loans in our held for investment portfolio.

As a result of these refinements, we believe that management is better able to allocate inherent losses previously accounted for in the additional qualitative reserve component of our allowance for loan losses to specific product types and credit risk grades, thus eliminating the additional qualitative reserve component of our allowance for loan losses in 2019.

Additionally, this improved specificity and consideration of current mortgage market conditions resulted in the allocation of a portion of the company’s allowance and provision for loan losses to our mortgage finance loan portfolio for the first time in 2019.

The increase in allowance allocated to commercial loans recorded at December 31, 2019 compared to 2018 is due to an increase in total criticized loans, primarily related to our energy and leveraged lending portfolios.

The decrease in allowance allocated to construction and real estate loans recorded at December 31, 2019 compared to 2018 is primarily related to a decrease in applied risk weights specific to these product types.

This decrease was the result of the refinements discussed above as well as management's continued evaluation of changing market conditions in these product types relative to historical loss experience.

At December 31, 2019 , we believe the allowance is appropriate and has been derived from consistent application of our methodology.

Should any of the factors considered by management in evaluating the appropriateness of the allowance for loan losses change, our estimate of inherent losses in the portfolio could also change, which would affect the level of future provisions for loan losses.

See Note 1 - Operations and Summary of Significant Accounting Policies and Note 4 - Loans Held for Investment and Allowance for Loan Losses in the accompanying notes to the consolidated financial statements included elsewhere in this report for details of the allowance for loan losses.

Total allowance for credit losses on loans $ 254,615 100 % $ 195,047 100 % $ 191,522 100 % $ 184,655 100 % $ 168,126 100 %

The overall increase in the allowance at December 31, 2020 compared to 2019 resulted from reserve build related to higher criticized loans levels and continued economic uncertainty from the COVID-19 pandemic, as mentioned above.

We recorded $198.8 million in net charge-offs during the year ended December 31, 2020, including $126.5 million in energy net charge-offs and $58.8 million in leveraged lending net charge-offs, all of which were loans that had been previously identified as problem loans, compared to $74.3 million during the year ended December 31, 2019.

See Note 1 - Operations and Summary of Significant Accounting Policies 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 details of the allowance for credit losses.

Loans Held for Sale

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Average demand deposits for the year ended December 31, 2020 increased $2.6 billion compared to 2019, and average interest-bearing deposits increased $3.6 billion.

The average cost of deposits increased to 1.19% in 2019 from 0.92% in 2018 due to increased

competition for deposits, as well as higher interest rates during the first half of 2019 prior to the interest rate reductions that began in August 2019.

The average cost of total deposits decreased to 0.47% in 2020 from 1.19% in 2019 due to lower interest rates during 2020.

The following table discloses our average deposits:

3 unchanged sentences

Interest-bearing transaction 4,090,591 3,535,282 3,044,300

Savings 12,346,904 9,780,532 7,986,135

Time deposits 2,867,579 2,351,698 1,292,864

Total average deposits $ 30,872,623 $ 24,656,616 $ 20,213,603

Uninsured deposits at December 31, 2019 were 53% of total deposits, compared to 57% of total deposits at December 31, 2018 and 59% of total deposits at December 31, 2017 .

Uninsured deposits at December 31, 2020 were 52% of total deposits, compared to 53% at December 31, 2019 and 57% at December 31, 2018.

The insured deposit data for 2020, 2019 and 2018 reflect the deposit insurance impact of "combined ownership segregation" of escrow and other accounts at an aggregate level but do not reflect an evaluation of all of the account styling distinctions that would determine the availability of deposit insurance to individual accounts based on FDIC regulations.

2 unchanged sentences

Months to maturity:

3 or less $ 159,428 $ 215,991 $ 193,982

Over 3 through 6 133,921 75,632 89,529

Over 6 through 12 203,626 165,973 100,177

Over 12 67,703 50,619 15,834

Total $ 564,678 $ 508,215 $ 399,522

Liquidity and Capital Resources

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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 increased liquidity assets in recent periods, which were $4.3 billion at December 31, 2019 and $2.9 billion at December 31, 2018 .

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.

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.

Liquidity assets totaled $9.0 billion at December 31, 2020 compared to $4.3 billion at December 31, 2019.

The following table summarizes the growth in and composition of liquidity assets:

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We also have access to incremental deposits through brokered retail certificates of deposit, or CDs.

These traditional brokered deposits are generally of short maturities, less than 12 months, 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.

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:

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Because our Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, we are allowed to continue to classify our trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital.

Our equity capital averaged $2.7 billion for the year ended December 31, 2019 as compared to $2.4 billion in 2018 and $2.1 billion in 2017 .

Our equity capital averaged $2.8 billion for the year ended December 31, 2020 compared to $2.7 billion in 2019 and $2.4 billion in 2018.

We have not paid any cash dividends on our common stock since we commenced operations.

While we have no plans to pay dividends on our common stock in the foreseeable future, it is anticipated that following the merger of the Company and IBTX the combined company will pay dividends to stockholders at the rate of $1.00 per share annually.

See the discussion at Risk Factors – Risks Relating to Our Securities.

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 on our capital, see Note 13 - Regulatory Restrictions in the accompanying notes to the consolidated financial statements included elsewhere in this report.

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

See Note 7 - Leases in the accompanying notes to the consolidated financial statements included elsewhere in this report for details of contractual lease obligations.

Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements included elsewhere in this report.

(in thousands)

After One But

(in thousands) Note

Reference Within One

Year After One But

Years After Three

Five Years After

Deposits without a stated maturity 9 $ 28,757,070 $ — $ — $ — $ 28,757,070

Time deposits 9 1,317,558 917,032 4,924 5 2,239,519

Lease liabilities 6 17,222 32,966 17,278 22,849 90,315

Federal funds purchased and customer repurchase agreements 10 111,751 — — — 111,751

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We had the following off-balance sheet contractual obligations as of December 31, 2020:

(in thousands)

After One But

(in thousands) Within

One Year After One But

Years After Three

Five Years After Five

Commitments to extend credit $ 3,021,442 $ 3,650,051 $ 1,638,198 $ 220,762 $ 8,530,453

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However, the policy noted below could be deemed to meet the SEC’s definition of a critical accounting policy.

Allowance for Loan Losses

Management considers the policies related to the allowance for loan losses as the most critical to the financial statement presentation.

The total allowance for loan losses includes activity related to allowances calculated in accordance with Accounting Standards Codification (“ASC”) 310, Receivables , and ASC 450, Contingencies .

The allowance for loan 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 inherent in the loan portfolio at the balance sheet date.

The allowance for loan losses is comprised of general reserves and specific reserves assigned to certain impaired loans.

Factors contributing to the determination of specific reserves include the creditworthiness of the borrower, and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral.

A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans.

For purposes of determining the general reserve, the portfolio is segregated by product types in order to recognize differing risk profiles among categories, and then further segregated by credit grades.

See “Summary of Loan Loss Experience” above and Note 4 – Loans Held for Investment and Allowance for Loan Losses 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 loan losses.

New Accounting Standards

ASU 2018-15 "Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40 - Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract)" ("ASU 2018-15") aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license).

ASU 2018-15 will be effective for us on January 1, 2020 and is not expected to have an impact on our consolidated financial statements as we currently apply this guidance in practice.

ASU 2018-13 "Fair Value Measurement (Topic 820) - Changes to the Disclosure Requirements for Fair Value Measurement" ("ASU 2018-13") removes the requirement to disclose the amount of and reasons for transfers between Level 1 and Level 2 fair value measurement methodologies, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements.

It also adds a requirement to disclose changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 measurements.

For certain unobservable inputs, entities may disclose other quantitative information in lieu of the weighted average if the other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements.

ASU 2018-13 will be effective for us on January 1, 2020 and is not expected to have a significant impact on our consolidated financial statements.

ASU 2016-13 "Financial Instruments - Credit Losses (Topic 326)" ("ASU 2016-13") requires an entity to utilize a new impairment model known as the current expected credit loss ("CECL") model to estimate its lifetime "expected credit loss" and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset.

The CECL model is expected to result in more timely recognition of credit losses.

ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities.

Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted.

ASU 2016-13, as updated, became effective for us on January 1, 2020.

Through the date of adoption, we held steering committee and working group meetings that included individuals from various functional areas relevant to the implementation of CECL.

Additionally, an assessment of our primary modeling tool was completed, which enabled us to complete parallel runs utilizing second and third quarter data, during which preliminary operational procedures and internal controls were designed.

Management's steering committee and working group also validated the appropriateness of, among other things, management’s decisions regarding portfolio segmentation, life of loan considerations, and reasonable and supportable forecasting methodology.

Based on our fourth quarter parallel run, review of the portfolio, including the composition, characteristics and quality of the underlying loans, and the prevailing economic conditions and forecasts as of the adoption date, we believe that adoption of ASU 2016-13 will result in an immaterial increase of approximately 5-6% to our allowance for credit losses.

This is consistent with our expectations given that our current portfolio is of shorter duration and commercially focused.

Supplemental Financial Data

The following tables present the calculation of certain non-GAAP measures that we consider to be key performance measures that management uses in assessing our financial performance.

While these non-GAAP measures may be widely used by investors, analysts and bank regulatory agencies to assess the financial performance of our company, they may not be comparable to similarly-titled measures reported by other companies.

These non-GAAP measures are individually identified and calculations are explained in the footnotes below the tables.

The following tables present reconciliations of these non-GAAP measures to the applicable amounts measured in accordance with GAAP.

(in thousands, except per share data)

Total common equity

Goodwill and intangibles

Tangible common equity

Common shares outstanding

Book value per common share

Tangible book value per common share(1)

Stockholders’ equity excluding preferred stock, less goodwill and intangibles, divided by shares outstanding at period end.

(in thousands, except percentage data)

Total common equity

Goodwill and intangibles

Tangible common equity

Goodwill and intangibles

Tangible common equity

Total common equity to total assets

Tangible common equity to total tangible assets(1)

Stockholders’ equity excluding preferred stock, less accumulated other comprehensive income and goodwill and intangibles, divided by total assets, less accumulated other comprehensive income and goodwill and intangibles.

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 credit losses expected to be recognized over the life of the loans in our portfolio.

The allowance for credit losses on loans 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.

Impact of Inflation and Changing Prices

The preparation of financial statements in conformity with GAAP requires management to measure the company’s financial position and operating results primarily in terms of historic dollars.

Changes in the relative value of money due to inflation or recession are generally not considered.

The primary effect of inflation on our operations is reflected in increased operating expenses.

Management considers changes in interest rates to impact our financial condition and results of operations to a far greater degree than changes in prices due to inflation.

Although interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate.

We manage our interest rate risk in several ways.

Refer to “Interest Rate Risk Management” in Item 7A for further discussion.

There can be no assurance that we will not be materially adversely affected by future changes in interest rates, as interest rates are highly sensitive to many factors that are beyond our control.

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-K

Item 7. Management’s Discussion and Analysis