Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the Company’s financial condition and results of operations for the years ended December 31, 2020 and 2019 should be read in conjunction with the Company’s Selected Consolidated Financial Data and the audited consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K. Certain risks, uncertainties and other factors, including those set forth under “Risk Factors” in Part I, Item 1A, and elsewhere in this Annual Report on Form 10-K, may cause actual results to differ materially from the results discussed in the forward-looking statements appearing in this discussion and analysis. Refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2019 Annual Report on Form 10K filed with the SEC on February 12, 2020, for discussion of our results of operations for the years ended December 31, 2019 and 2018.
Forward-Looking Statements
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, 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. 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-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. Government, including policies of the U.S. 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 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.
• 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 MCA loan volumes.
• Changes in accounting principles, policies, practices or guidelines.
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• 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.
• 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 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.
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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 $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
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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 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.
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Consolidated Daily Average Balances, Average Yields and Rates
Year ended December 31,
2020 2019 2018
(in thousands except percentages) Average
Balance Revenue /
Expense Yield /
Rate Average
Balance Revenue /
Expense Yield /
Rate Average
Balance Revenue /
Expense Yield /
Rate
Assets
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
Transaction deposits $ 4,090,591 $ 32,836 0.80 % $ 3,535,282 $ 68,908 1.95 % $ 3,044,300 $ 47,738 1.57 %
Savings deposits 12,346,904 74,950 0.61 % 9,780,532 168,856 1.73 % 7,986,135 114,255 1.43 %
Time deposits 2,867,579 38,331 1.34 % 2,351,698 55,773 2.37 % 1,292,864 23,123 1.79 %
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 %
Subordinated notes 282,299 16,764 5.94 % 281,936 16,764 5.95 % 281,574 16,764 5.95 %
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
Other liabilities 295,710 246,931 121,203
Stockholders’ equity 2,836,747 2,679,021 2,365,499
Total liabilities and stockholders’ equity
$ 37,516,201 $ 31,016,005 $ 25,197,689
Net interest income(2) $ 872,920 $ 985,975 $ 920,783
Net interest margin 2.39 % 3.28 % 3.78 %
Net interest spread 2.09 % 2.54 % 3.12 %
Loan spread(3) 3.43 % 3.59 % 4.04 %
(1) The loan averages include non-accrual loans which are stated net of unearned income. Loan interest income includes loan fees totaling $61.3 million, $57.1 million and $71.0 million for the years ended December 31, 2020, 2019 and 2018, respectively.
(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.
Years Ended December 31,
2020/2019 2019/2018
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 $ 8,906 $ 34,391 $ (25,485) $ 7,165 $ 5,787 $ 1,378
Loans held for sale (76,157) (61,542) (14,615) 41,286 51,381 (10,095)
Loans held for investment, mortgage finance loans 43,547 56,230 (12,683) 60,227 78,979 (18,752)
Loans held for investment (242,497) (22,700) (219,797) 56,540 38,729 17,811
Federal funds sold and securities purchased under resale agreements (836) 1,092 (1,928) (2,263) (2,329) 66
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:
Transaction deposits (36,072) 10,856 (46,928) 21,170 7,644 13,526
Savings deposits (93,906) 45,495 (139,401) 54,601 27,534 27,067
Time deposits (17,442) 12,330 (29,772) 32,650 15,517 17,133
Other borrowings (48,259) 1,741 (50,000) 27,527 18,344 9,183
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)
(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 $868.8 million for the year ended December 31, 2020 compared to $979.7 million for 2019. 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 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.
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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 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
Year ended December 31,
(in thousands) 2020 2019 2018
Service charges on deposit accounts $ 11,620 $ 11,320 $ 12,787
Wealth management and trust fee income 9,998 8,810 8,148
Brokered loan fees 46,423 29,738 22,532
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
(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 $93.1 million during the year ended December 31, 2020 to $185.5 million, compared to $92.4 million for 2019. 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
Year ended December 31,
(in thousands) 2020 2019(1) 2018(1)
Salaries and employee benefits $ 340,529 $ 328,483 $ 300,899
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
Communications and technology 103,054 44,826 30,056
FDIC insurance assessment 25,955 20,093 24,307
Servicing-related expenses 64,625 22,573 14,934
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 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.
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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:
December 31,
(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
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
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. 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. We also participate in syndicated loan relationships, both as a participant and as an agent. As of December 31, 2020, we had $1.9 billion in syndicated loans, $435.5 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 December 31, 2020, none 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 December 31, 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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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) Amount Percent of
Total Loans Held for Investment
Industry type:
Mortgage finance loans $ 9,079,409 37.0 %
Real estate and construction 5,247,480 21.4 %
Financials excluding banks 5,067,487 20.7 %
Oil & gas and pipelines 1,020,033 4.2 %
Healthcare and pharmaceuticals 460,517 1.9 %
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 %
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 %
Total loans held for investment $ 24,501,830 100.0 %
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, 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. 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. This category also includes loans to companies involved in investment management and securities and commodities trading.
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We believe the loans we originate are appropriately collateralized under our credit standards. Approximately 98% of our loans held for investment are secured by collateral. 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) Amount Percent of
Total Loans Held for Investment
Collateral type:
Mortgage finance loans $ 9,079,409 37.1 %
Business assets 6,848,036 28.0 %
Real property 5,794,624 23.6 %
Energy 766,217 3.1 %
U. S. 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 %
Unsecured 587,276 2.4 %
Total loans held for investment $ 24,501,830 100.0 %
As noted in the table above, approximately 21.4% of our loans held for investment as of December 31, 2020 are secured by real property. The table below summarizes our total real estate loan portfolio, which includes real estate loans and construction loans, as segregated by the type of property securing the credit. 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) Amount Percent of
Total
Real Estate
Loans
Property type:
Market risk
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 %
Industrial buildings 314,569 5.4 %
Residential lots 286,981 5.0 %
Shopping center/mall buildings 257,404 4.4 %
Commercial lots 75,480 1.3 %
Other 168,440 2.9 %
Other than market risk
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 %
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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) Amount Percent of
Total
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 %
The determination of collateral value is critically important when financing real estate. As a result, obtaining current and objectively prepared appraisals is a major part of our underwriting and monitoring processes. We engage a variety of professional firms to supply appraisals, market studies and feasibility reports, environmental assessments and project site inspections to complement our internal resources to underwrite and monitor these credit exposures. Generally, our policy requires a new appraisal every three years. 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.
Appraisals are, in substantially all cases, reviewed by a third party to determine the reasonableness of the appraised value. The third party reviewer will challenge whether or not the data used is appropriate and relevant, form an opinion as to the appropriateness of the appraisal methods and techniques used, and determine if overall the analysis and conclusions of the appraiser can be relied upon. Additionally, the third party reviewer provides a detailed report of that analysis. Further review may be conducted by our credit officers, as well as by the Bank’s managed asset committee as conditions warrant. These additional steps of review are undertaken to confirm that the underlying appraisal and the third party analysis can be relied upon. If we have differences, we address those with the reviewer and determine an appropriate resolution. Both the appraisal process and the appraisal review process can be less reliable in establishing accurate collateral values during and following periods of economic weakness due to the lack of comparable sales and the limited availability of financing to support an active market of potential purchasers.
Large Credit Relationships
We originate and maintain large credit relationships with numerous customers in the ordinary course of business. The legal lending limit of our Bank is approximately $506.4 million. We employ much lower house limits which vary by assigned risk grade, product and collateral type. Such house limits, which generally range from $20 million to $60 million, may be exceeded with appropriate authorization for exceptionally strong borrowers and otherwise where business opportunity and perceived credit risk warrant a somewhat larger investment. We consider large credit relationships to be those with commitments equal to or in excess of $20.0 million. The following table provides additional information on our large held for investment credit relationships, excluding mortgage finance, outstanding at year-end:
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
$20.0 million to $29.9 million 167 4,095,449 2,414,768 196 4,708,982 3,103,200
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Growth in period-end outstanding balances related to large credit relationships primarily resulted from an increase in the number of commitments. 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:
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
$20.0 million to $29.9 million 24,524 14,460 24,025 15,833
Loan Maturities and Interest Rate Sensitivity
December 31, 2020
(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 — —
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
Interest rate sensitivity for selected loans with:
Predetermined interest rates $ 3,127,325 $ 1,476,707 $ 1,136,376 $ 514,242
Floating or adjustable interest rates 21,374,505 12,686,805 7,665,909 1,021,791
Total loans held for investment $ 24,501,830 $ 14,163,512 $ 8,802,285 $ 1,536,033
Interest Reserve 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. The use of interest reserves is carefully controlled by our underwriting standards, which consider the feasibility of the project, the creditworthiness of the borrower and guarantors and the loan-to-value coverage of the collateral. The interest reserve allows the borrower to draw loan funds to pay interest charges on the outstanding balance of the loan when financial conditions precedent are met. When drawn, the interest is capitalized and added to the loan balance, subject to conditions specified during the initial underwriting and at the time the credit is approved. We have ongoing controls for monitoring compliance with loan covenants, advancing funds and determining default conditions.
When we finance land on which improvements will be constructed, construction funds are generally not advanced until the borrower has received lease or purchase commitments which will meet cash flow coverage requirements and/or our analysis of market conditions and project feasibility indicates to our satisfaction that such lease or purchase commitments are forthcoming or other sources of repayment have been identified to repay the loan. It is our general policy to require a substantial equity investment by the borrower to complement the Bank's credit commitment. Any such required borrower investment is first contributed and invested in the project before any draws are allowed under the Bank's credit commitment. We require current financial statements of the borrowing entity and guarantors, as well as conduct periodic inspections of the project and analysis of whether the project is on schedule or delayed. Updated appraisals are ordered when necessary to validate the collateral values to support advances, including reserve interest. Advances of interest reserves are discontinued if collateral values do not support the advances or if the borrower does not comply with other terms and conditions in the loan agreements. In addition, most of our construction lending is performed in Texas and our lenders are very familiar with trends in local real estate. If at any time we believe that our collateral position is jeopardized, we retain the right to stop the use of interest reserves. As of December 31, 2020 and December 31, 2019, none of our loans with interest reserves were on non-accrual.
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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:
As of December 31,
(in thousands) 2020 2019 2018
Non-accrual loans(1)
Commercial
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
Energy
Oil and gas properties 51,724 125,049 37,532
Total Energy 51,724 125,049 37,532
Real estate
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
Total non-accrual loans 121,989 225,384 80,375
OREO(2) — — 79
Total non-performing assets $ 121,989 $ 225,384 $ 80,454
Restructured loans - accruing $ — $ — $ —
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.
(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. 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 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. We monitor these loans closely and review their performance on a regular basis. 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.
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Summary of Loan Loss Experience
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. 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:
Year Ended December 31,
(in thousands except percentage and multiple data) 2020 2019 2018 2017 2016
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:
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
Recoveries:
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 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
Allowance for off-balance sheet credit losses:
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
Ending balance $ 17,434 $ 8,640 $ 11,434 $ 9,071 $ 11,422
Total allowance for credit losses $ 272,049 $ 203,687 $ 202,956 $ 193,726 $ 179,548
Total provision for credit losses $ 258,000 $ 75,000 $ 87,000 $ 44,000 $ 77,000
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 %
Total provision for credit losses to average LHI 1.03 % 0.32 % 0.42 % 0.24 % 0.46 %
Recoveries to total charge-offs 4.00 % 4.34 % 3.72 % 13.99 % 16.73 %
Allowance for off-balance sheet credit losses to off-balance sheet credit commitments 0.20 % 0.10 % 0.14 % 0.13 % 0.19 %
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.
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The following table presents a summary of our allowance for credit losses on loans by portfolio segment for the past five years:
December 31,
2020 2019 2018 2017 2016
(in thousands except
percentage data)
Reserve % of
Loans Reserve % of
Loans Reserve % of
Loans Reserve % of
Loans Reserve % of
Loans
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 %
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 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
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 1 - Operations and Summary of Significant Accounting Policies and Note 5 - Certain Transfers of Financial Assets in the accompanying notes to the consolidated financial statements included elsewhere in this report.
Deposits
We compete for deposits by offering a broad range of products and services to our customers. While this includes offering competitive interest rates and fees, the primary means of competing for deposits is convenience and service to our customers. However, our strategy to provide service and convenience to customers does not include a large branch network. Our Bank offers banking centers, courier services and online and mobile banking. BankDirect and Bask Bank, our online banking divisions, serve customers on a 24 hours-a-day, 7 days-a-week basis solely through online banking.
Average total deposits for the year ended December 31, 2020 increased $6.2 billion compared to 2019. 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 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:
Year Ended December 31,
(in thousands) 2020 2019 2018
Non-interest-bearing $ 11,567,549 $ 8,989,104 $ 7,890,304
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, 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.
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Maturity of Domestic CDs and Other Time Deposits in Amounts of $100,000 or More
December 31,
(in thousands) 2020 2019 2018
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
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 and 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 years ended December 31, 2020 and 2019, 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. 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:
December 31,
(in thousands except percentage data) 2020 2019 2018
Federal funds sold and securities purchased under resale agreements $ — $ 30,000 $ 50,190
Interest-bearing deposits 9,032,807 4,233,766 2,815,684
Total liquidity assets $ 9,032,807 $ 4,263,766 $ 2,865,874
Total liquidity assets as a percent of:
Total loans held for investment 37.0 % 17.3 % 12.7 %
Total earning assets 24.6 % 13.5 % 10.5 %
Total deposits 29.1 % 16.1 % 13.9 %
Our liquidity needs 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.
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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 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:
December 31,
(in thousands) 2020 2019
Deposits from core customers $ 27,581,532 $ 22,549,568
Deposits from core customers as a percent of total deposits 89.0 % 85.2 %
Relationship brokered deposits $ 1,771,883 $ 1,617,247
Relationship brokered deposits as a percent of average total deposits 5.7 % 6.1 %
Traditional brokered deposits $ 1,643,174 $ 2,311,778
Traditional brokered deposits as a percent of total deposits 5.3 % 8.7 %
Average deposits from core customers $ 26,537,612 $ 20,747,292
Average deposits from core customers as a percent of average total deposits 86.0 % 84.1 %
Average relationship brokered deposits $ 2,099,652 $ 2,096,287
Average relationship brokered deposits as a percent of average total deposits 6.8 % 8.5 %
Average traditional brokered deposits $ 2,235,359 $ 1,813,037
Average traditional brokered deposits as a percent of average total deposits 7.2 % 7.4 %
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 2020 and 2019 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:
December 31,
(in thousands) 2020 2019 2018
Federal funds purchased $ 107,600 $ 132,270 $ 629,169
Repurchase agreements 4,151 9,496 12,005
FHLB borrowings 3,000,000 2,400,000 3,900,000
Line of credit — — —
Total short-term and other borrowings $ 3,111,751 $ 2,541,766 $ 4,541,174
For additional information on our short-term and other borrowings, see Note 10 - Short-Term and Other Borrowings in the accompanying notes to the consolidated financial statements included elsewhere in this report.
From November 2002 to September 2006 various Texas Capital Statutory Trusts were created and subsequently issued floating rate trust preferred securities in various private offerings totaling $113.4 million. 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 $2.8 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. 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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Commitments and Contractual Obligations
The following table presents, as of December 31, 2020, significant fixed and determinable contractual obligations to third parties by payment date. Amounts in the table do not include accrued or accruing interest. 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) Note
Reference Within One
Year After One But
Within Three
Years After Three
But Within
Five Years After
Five
Years Total
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
FHLB borrowings 10 3,000,000 — — — 3,000,000
Subordinated notes 11 — — — 282,490 282,490
Trust preferred subordinated debentures 11 — — — 113,406 113,406
Total contractual obligations $ 33,203,601 $ 949,998 $ 22,202 $ 418,750 $ 34,594,551
Off-Balance Sheet Arrangements
We had the following off-balance sheet contractual obligations as of December 31, 2020:
(in thousands) Within
One Year After One But
Within Three
Years After Three
But Within
Five Years After Five
Years Total
Commitments to extend credit $ 3,021,442 $ 3,650,051 $ 1,638,198 $ 220,762 $ 8,530,453
Standby and commercial letters of credit 178,571 78,912 11,411 — 268,894
Total financial instruments with off-balance sheet risk $ 3,200,013 $ 3,728,963 $ 1,649,609 $ 220,762 $ 8,799,347
Due to the nature of our unfunded loan commitments, including unfunded lines of credit, the amounts presented in the table above do not necessarily represent amounts that we anticipate funding in the periods presented above. Commitments to extend credit do not include our mortgage finance arrangements with mortgage loan originators through our mortgage warehouse lending division, which are established as uncommitted "guidance" purchase and sale facilities under which the mortgage originator has no obligation to offer and we have no obligation to purchase interests in the mortgage loans subject to the arrangements. See Note 1 - Operations and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report.
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. 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 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
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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.