Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition as of March 31, 2021 and December 31, 2020 and results of operations for the three month periods ended March 31, 2021 and March 31, 2020 should be read in conjunction with our consolidated financial statements and notes to the financial statements for the year ended December 31, 2020, and the other information included in our Annual Report on Form 10-K for the year ended December 31, 2020 (the "2020 Form 10-K"). Certain risks, uncertainties and other factors, including those set forth under "Risk Factors" in Part I, Item 1A of the 2020 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.
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.
Significant transactions affecting our financial statements during the three months ended March 31, 2021 included:
• Issuance of 5.75% fixed rate non-cumulative perpetual preferred stock, Series B (the "Series B Preferred Stock") and issuance and sale of 12,000,000 depositary shares, each representing a 1/40th interest in a share of the Series B Preferred Stock. Net proceeds from the sale totaled $289.7 million. The additional equity is being used for general corporate purchases, including funding regulatory capital infusions into the Bank, and may be used to redeem, in whole or in part and subject to receipt of all applicable regulatory approvals, our 6.5% non-cumulative perpetual preferred stock Series A, par value $0.01 per share, in accordance with its terms.
• Issuance of $275.0 million in senior unsecured credit-linked notes that mature on September 30, 2024. The net proceeds of the offering will be used to expand the Bank's warehouse lending program and better serve our clients in all market environments.
Impact of COVID-19 Pandemic
The COVID-19 pandemic and related restrictive measures taken by governments, businesses and individuals caused unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that we serve. As the restrictive measures have been eased during 2020 and into 2021, the U.S. economy has begun to recover and with the availability and distribution of a COVID-19 vaccine, we anticipate continued improvements in commercial and consumer activity and the U.S. economy. As of March 31, 2021, governor of Texas removed all restrictions initially set in place which has allowed businesses to reopen at full capacities.
While positive headwinds exist, we recognize that our business and consumer customers are experiencing varying degrees of financial distress, which is expected to continue into the second quarter of 2021, especially if new COVID-19 variant infections
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increase and new economic restrictions are mandated. Commercial activity has improved, but has not returned to the levels existing prior to the outbreak of the pandemic, which 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 borrowing base includes customers in industries such as energy, hotel/lodging, restaurants, entertainment, retail and commercial real estate, all of which have been 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.
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, however, future economic conditions are subject to significant uncertainty. Uncertainties associated with the pandemic include the duration of the COVID-19 outbreak and any related variant infections, the availability and effectiveness of COVID-19 vaccines, the impact to our customers, employees and vendors and the impact to the economy as a whole. COVID-19 had a significant adverse impact on our business, financial position and operating results for the year ended December 31, 2020 and while uncertainty still exists, we believe we are well-positioned to operate effectively through the present economic environment and do expect to experience improvements in our financial results during 2021.
While we are still operating under our business continuity plan, we have begun to bring certain employees back into the office. 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 continue to take additional precautions within our branch locations, including enhanced cleaning procedures, to ensure the safety of our customers and our employees.
Results of Operations
Summary of Performance
We reported net income of $71.9 million and net income available to common stockholders of $68.2 million for the first quarter of 2021 compared to a net loss of $16.7 million and net loss available to common stockholders of $19.1 million for the first quarter of 2020. On a fully diluted basis, earnings per common share were $1.33 for the first quarter of 2021, compared to a loss per common share of $0.38 for the first quarter of 2020. Return on average common equity (“ROE”) was 10.08% and return on average assets ("ROA") was 0.73% for the first quarter of 2021, compared to a negative 2.85% and negative 0.20%, respectively, for the first quarter of 2020. The increase in net income, ROE and ROA for the first quarter of 2021 resulted primarily from a $102.0 million decrease in provision for credit losses.
Details of the changes in the various components of net income are discussed below.
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QUARTERLY FINANCIAL SUMMARIES – UNAUDITED
Consolidated Daily Average Balances, Average Yields and Rates
Three months ended March 31, 2021 Three months ended March 31, 2020
(in thousands except percentages) Average
Balance Revenue/
Expense Yield/
Rate Average
Balance Revenue/
Expense Yield/
Rate
Assets
Investment securities – taxable $ 3,225,786 $ 8,112 1.02 % $ 42,799 $ 274 2.57 %
Investment securities – non-taxable(2)
196,785 2,247 4.63 % 195,578 2,417 4.97 %
Federal funds sold and securities purchased under resale agreements
4,605 1 0.07 % 199,727 614 1.24 %
Interest-bearing deposits in other banks
11,840,942 2,932 0.10 % 6,225,948 19,586 1.27 %
Loans held for sale 243,326 1,595 2.66 % 3,136,381 27,480 3.52 %
Loans held for investment, mortgage finance
8,177,759 64,942 3.22 % 7,054,682 55,324 3.15 %
Loans held for investment(1)(2) 15,457,888 149,196 3.91 % 16,598,775 201,781 4.89 %
Less reserve for credit losses on loans 254,697 — — 201,837 — —
Loans held for investment, net 23,380,950 214,138 3.71 % 23,451,620 257,105 4.41 %
Total earning assets 38,892,394 229,025 2.39 % 33,252,053 307,476 3.72 %
Cash and other assets 1,064,679 976,520
Total assets $ 39,957,073 $ 34,228,573
Liabilities and Stockholders’ Equity
Transaction deposits $ 3,991,966 $ 5,861 0.60 % $ 3,773,067 $ 13,582 1.45 %
Savings deposits 12,889,974 10,788 0.34 % 11,069,429 35,961 1.31 %
Time deposits 2,204,242 3,355 0.62 % 2,842,535 12,631 1.79 %
Total interest-bearing deposits 19,086,182 20,004 0.43 % 17,685,031 62,174 1.41 %
Other borrowings 2,686,398 2,592 0.39 % 3,020,255 10,251 1.37 %
Long-term debt 464,731 5,743 5.01 % 395,571 5,264 5.35 %
Total interest-bearing liabilities 22,237,311 28,339 0.52 % 21,100,857 77,689 1.48 %
Demand deposits 14,421,505 10,003,495
Other liabilities 309,644 270,868
Stockholders’ equity 2,988,613 2,853,353
Total liabilities and stockholders’ equity
$ 39,957,073 $ 34,228,573
Net interest income(2) $ 200,686 $ 229,787
Net interest margin 2.09 % 2.78 %
Net interest spread 1.87 % 2.24 %
Loan spread(3) 3.45 % 3.35 %
(1) The loan averages include non-accrual loans and are stated net of unearned income.
(2) Taxable equivalent rates used where applicable.
(3) Yield on loans, net of reserves, less funding cost including all deposits and borrowed funds.
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Volume/Rate Analysis
The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to differences in the average interest rate on those assets and liabilities.
Three months ended March 31, 2021/2020
Net
Change Change due to(1)
(in thousands) Volume Yield/Rate(2)
Interest income:
Investment securities $ 7,668 $ 35,943 $ (28,275)
Loans held for sale (25,885) (25,320) (565)
Loans held for investment, mortgage finance loans 9,618 8,796 822
Loans held for investment (52,585) (13,871) (38,714)
Federal funds sold and securities purchased under resale agreements (613) (602) (11)
Interest-bearing deposits in other banks (16,654) 17,730 (34,384)
Total (78,451) 22,676 (101,127)
Interest expense:
Transaction deposits (7,721) 789 (8,510)
Savings deposits (25,173) 5,930 (31,103)
Time deposits (9,276) (2,841) (6,435)
Other borrowings (7,659) (1,137) (6,522)
Long-term debt 479 920 (441)
Total (49,350) 3,661 (53,011)
Net interest income $ (29,101) $ 19,015 $ (48,116)
(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 $200.1 million for the three months ended March 31, 2021, compared to $228.3 million for the same period in 2020. The decrease was primarily due to decreases in yields on earning assets and a shift in earning asset composition, offset by a decrease in funding costs.
Average earning assets for the three months ended March 31, 2021 increased by $5.6 billion compared to the same period in 2020, and included a $3.2 billion increase in average total investment securities, reflecting the deployment of excess liquidity into higher-yielding investment securities and a $5.4 billion increase in average liquidity assets, partially offset by a $2.9 billion decrease in average loans held for sale. Throughout 2020, management took deliberate actions to increase liquidity balances to ensure we had the balance sheet strength to serve our clients during the COVID-19 pandemic and through the first three months of 2021 these balances have remained high. The decrease in average loans held for sale compared to the first quarter of 2020 resulted from holding purchased loans for shorter durations than in prior periods in order to limit exposure to forbearance risk caused by economic uncertainties. The decline in net interest income on loans held for sale resulting from shorter hold times was offset by an increase in non-interest income. Average interest-bearing liabilities increased for the three months ended March 31, 2021 compared to the same period in 2020, primarily due to a $1.4 billion increase in average interest-bearing deposits and a $69.2 million increase in long-term debt, partially offset by a $333.9 million decrease in average other borrowings. Average demand deposits for the three months ended March 31, 2021 increased to $14.4 billion from $10.0 billion for the three months ended March 31, 2020.
Net interest margin for the three months ended March 31, 2021 was 2.09% compared to 2.78% for the same period in 2020. 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 investment securities and liquidity assets, as well as declines in loans held for sale and loans held for investment, excluding mortgage finance, partially offset by lower funding costs compared to the first quarter of 2020.
The yield on total loans held for investment decreased to 3.71% for the three months ended March 31, 2021 compared to 4.41% for the same period in 2020, and the yield on earning assets decreased to 2.39% for the three months ended March 31, 2021 compared to 3.72% for the same period in 2020. The average cost of total deposits decreased to 0.24% for the first quarter of 2021 from 0.90% for the first quarter of 2020 and total funding costs, including all deposits, long-term debt and stockholders' equity decreased to 0.29% for the first quarter of 2021 compared to 0.92% for the first quarter of 2020.
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Non-interest Income
Three months ended March 31,
(in thousands) 2021 2020
Service charges on deposit accounts $ 4,716 $ 3,293
Wealth management and trust fee income 2,855 2,467
Brokered loan fees 9,311 8,015
Servicing income 9,009 4,746
Swap fees 526 2,757
Net gain/(loss) on sale of loans held for sale 5,572 (13,000)
Other(1) 7,103 3,502
Total non-interest income $ 39,092 $ 11,780
(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 $27.3 million during the three months ended March 31, 2021 to $39.1 million, compared to $11.8 million for the same period in 2020. This increase was primarily due to a $18.6 million increase in net gain/(loss) on sale of loans held for sale, a $4.3 million increase in servicing income and a $3.6 million increase in other non-interest income. The increase in net gain/(loss) on sale of loans held for sale was due to lower hedge costs in the first quarter of 2021 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 servicing income was due to an increase in the outstanding balance of our servicing portfolio.
Non-interest Expense
Three months ended March 31,
(in thousands) 2021 2020
Salaries and employee benefits $ 87,522 $ 77,193
Net occupancy expense 8,274 8,712
Marketing 1,697 8,522
Legal and professional 8,277 17,466
Communications and technology 15,969 13,791
FDIC insurance assessment 6,613 5,849
Servicing-related expenses 12,989 16,354
Merger-related expenses — 7,270
Other(1) 8,975 10,260
Total non-interest expense $ 150,316 $ 165,417
(1) Other expense includes such items as courier expenses, regulatory assessments other than FDIC insurance, insurance expenses and other general operating expenses.
Non-interest expense for the three months ended March 31, 2021 decreased $15.1 million compared to the same period in 2020. The decrease was primarily due to decreases in marketing expense, legal and professional expense, servicing-related expenses and merger-related expenses, partially offset by increases in salaries and employee benefits and communication and technology expense.
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Analysis of Financial Condition
Loans Held for Investment
The following table summarizes our loans held for investment on a gross basis by portfolio segment:
March 31, 2021 December 31, 2020
(in thousands)
Commercial $ 8,969,224 $ 8,861,580
Energy 691,806 766,217
Mortgage finance 9,009,081 9,079,409
Real estate 5,810,590 5,794,624
Gross loans held for investment $ 24,480,701 $ 24,501,830
Deferred income (net of direct origination costs) (72,446) (70,970)
Allowance for credit losses on loans (242,484) (254,615)
Total loans held for investment, net $ 24,165,771 $ 24,176,245
Total gross loans held for investment were $24.5 billion at March 31, 2021, a decline of $21.1 million from December 31, 2020 primarily due to declines in our energy and mortgage finance portfolios, partially offset by an increase in commercial loans, primarily due to the continued funding of loans under the Paycheck Protection Plan during the first quarter of 2021. The decline in the energy portfolio is consistent with our strategy of planned reductions in this portfolio as it has experienced higher historic losses. 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. 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. Despite the decline in the first quarter of 2021, balances in this portfolio remain elevated related to increases in volumes driven by continued lower long-term interest rates.
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 March 31, 2021, we had $1.8 billion in syndicated loans, $475.9 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 March 31, 2021, 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 March 31, 2021, a majority of our loans held for investment, excluding mortgage finance loans and other national lines of business, were to businesses with headquarters or operations in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this state. We also make loans to customers that are secured by assets located outside of Texas. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for credit losses.
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Non-performing Assets
Non-performing assets include non-accrual loans and leases and repossessed assets. The table below summarizes our non-performing assets by type and by type of property securing the credit:
(in thousands) March 31, 2021 December 31, 2020 March 31, 2020
Non-accrual loans(1)
Commercial
Assets of the borrowers $ 20,264 $ 18,776 $ 37,040
Inventory 6,633 3,547 17,561
Other 11,297 9,773 7,352
Total commercial 38,194 32,096 61,953
Energy
Oil and gas properties 29,368 51,724 151,858
Total energy 29,368 51,724 151,858
Real estate
Assets of the borrowers 14,289 14,496 —
Commercial property 9,543 13,569 1,099
Hotel/motel 4,619 4,619 —
Single family residences 1,717 218 1,421
Other — 5,267 2,834
Total real estate 30,168 38,169 5,354
Total non-performing assets $ 97,730 $ 121,989 $ 219,165
Restructured loans - accruing $ — $ — $ —
Loans held for investment past due 90 days and accruing(2) 6,187 12,541 21,274
Loans held for sale non-accrual (3) — 6,966 —
Loans held for sale past due 90 days and accruing(4) 16,359 16,667 9,014
(1) As of March 31, 2021, December 31, 2020 and March 31, 2020, non-accrual loans included $33.7 million, $45.4 million and $22.3 million, respectively, in loans that met the criteria for restructured.
(2) At March 31, 2021, December 31, 2020 and March 31, 2020, loans past due 90 days and still accruing includes premium finance loans of $3.1 million, $6.4 million and $8.6 million, respectively.
(3) 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.
(4) 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 March 31, 2021 decreased $24.3 million from December 31, 2020 and decreased $121.4 million compared to March 31, 2020. The decrease from both December 31, 2020 and March 31, 2020 was primarily due to a decline in non-accrual energy loans.
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 March 31, 2021, we had $145.1 million in loans of this type, compared to $193.2 million at December 31, 2020 and $98.2 million at March 31, 2020.
Summary of Credit Loss Experience
The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the allowance for credit losses at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. We recorded a $6.0 million negative provision for credit losses for the first quarter of 2021, compared to provisions of $32.0 million in the fourth quarter of 2020 and $96.0 million in the first quarter of 2020. The decrease from the fourth quarter of 2020 resulted primarily from a decrease in charge-offs and improvement in the economic outlook as the economy begins to recover from the impacts of the COVID-19 pandemic. We recorded $6.4 million in net charge-offs during the first quarter of 2021, compared to $65.4 million during the fourth quarter of 2020 and $57.7 million during the first quarter of 2020. Criticized loans totaled $945.1 million at March 31, 2021, compared to $918.4 million at December 31, 2020 and $675.9 million at March 31, 2020. Criticized loan levels remain elevated when compared to pre-pandemic levels due to the downgrade of loans to borrowers that have been impacted by the COVID-19 pandemic.
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The table below presents a summary of our loan loss experience:
Three months ended March 31, 2021 Year ended December 31, 2020 Three months ended March 31, 2020
(in thousands except percentage and multiple data)
Allowance for credit losses on loans:
Beginning balance $ 254,615 $ 195,047 $ 195,047
Impact of CECL adoption — 8,585 8,585
Loans charged-off:
Commercial 2,451 73,360 20,653
Energy 5,732 133,522 37,730
Real estate — 180 —
Total charge-offs 8,183 207,062 58,383
Recoveries:
Commercial 1,050 1,277 257
Energy 715 6,999 423
Total recoveries 1,765 8,276 680
Net charge-offs 6,418 198,786 57,703
Provision for credit losses on loans (5,713) 249,769 95,029
Ending balance $ 242,484 $ 254,615 $ 240,958
Allowance for off-balance sheet credit losses:
Beginning balance $ 17,434 8,640 $ 8,640
Impact of CECL adoption — 563 563
Provision for off-balance sheet credit losses (287) 8,231 971
Ending balance $ 17,147 $ 17,434 $ 10,174
Total allowance for credit losses $ 259,631 $ 272,049 $ 251,132
Total provision for credit losses $ (6,000) $ 258,000 $ 96,000
Allowance for credit losses on loans to LHI 0.99 % 1.04 % 0.99 %
Net charge-offs to average LHI 0.11 % 0.80 % 0.98 %
Total provision for credit losses to average LHI (0.10) % 1.03 % 1.63 %
Recoveries to total charge-offs 21.57 % 4.00 % 1.17 %
Allowance for off-balance sheet credit losses to off-balance sheet credit commitments
0.20 % 0.20 % 0.13 %
Total allowance for credit losses to LHI 1.06 % 1.11 % 1.03 %
Allowance as a multiple of non-performing loans 2.5 x 2.1 x 1.1 x
The allowance for credit losses, including the allowance for losses on unfunded commitments reported on the consolidated balance sheets in other liabilities, totaled $259.6 million at March 31, 2021, $272.0 million at December 31, 2020 and $251.1 million at March 31, 2020. The total allowance for credit losses as a percentage of loans held for investment was 1.06% at March 31, 2021, compared to 1.11% at December 31, 2020 and 1.03% at March 31, 2020. The total allowance for credit losses as a percentage of loans held for investment, excluding mortgage finance, was 1.69% at March 31, 2021, compared to 1.77% at December 31, 2020 and 1.49% at March 31, 2020. The increase in the total allowance as a percentage of loans held for investment at March 31, 2021, compared to March 31, 2020, is due primarily to an increase in the allowance for credit losses, resulting from reserve build related to higher criticized loan levels and continued economic uncertainty related to the COVID-19 pandemic.
Loans Held for Sale
Through our MCA program we commit to purchase residential mortgage loans from independent correspondent lenders and deliver those loans into the secondary market via whole loan sales to independent third parties or in securitization transactions to Ginnie Mae and GSEs such as Fannie Mae and Freddie Mac. For additional information on our loans held for sale portfolio, see Note 5 - Certain Transfers of Financial Assets in the accompanying notes to the consolidated financial statements included elsewhere in this report.
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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 year ended December 31, 2020 and the three months ended March 31, 2021, 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 significantly increased our liquidity assets to ensure that we had the balance sheet strength to serve our clients during the COVID-19 pandemic, and through the first quarter of 2021 these balances have remained high. The following table summarizes the composition of liquidity assets:
(in thousands except percentage data) March 31, 2021 December 31, 2020 March 31, 2020
Federal funds sold and securities purchased under resale agreements $ — $ — $ 30,000
Interest-bearing deposits 11,212,276 9,032,807 9,468,189
Total liquidity assets $ 11,212,276 $ 9,032,807 $ 9,498,189
Total liquidity assets as a percent of:
Total loans held for investment 45.9 % 37.0 % 38.9 %
Total earning assets 28.8 % 24.6 % 27.3 %
Total deposits 33.6 % 29.1 % 35.0 %
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.
We also have access to incremental deposits through brokered retail certificates of deposit, or CDs. These traditional brokered deposits are generally of short maturities and are used to fund temporary differences in the growth in loan balances, including growth in loans held for sale or other specific categories of loans as compared to customer deposits. The following table summarizes our period-end and average core customer deposits, relationship brokered deposits and traditional brokered deposits:
(in thousands) March 31, 2021 December 31, 2020 March 31, 2020
Deposits from core customers $ 30,102,156 $ 27,581,532 $ 22,368,584
Deposits from core customers as a percent of total deposits 90.1 % 89.0 % 82.4 %
Relationship brokered deposits $ 1,933,376 $ 1,771,883 $ 2,101,329
Relationship brokered deposits as a percent of average total deposits 5.8 % 5.7 % 7.7 %
Traditional brokered deposits $ 1,356,438 $ 1,643,174 $ 2,664,350
Traditional brokered deposits as a percent of total deposits 4.1 % 5.3 % 9.8 %
Average deposits from core customers(1) $ 29,980,945 $ 26,537,612 $ 23,642,481
Average deposits from core customers as a percent of average total deposits 89.5 % 86.0 % 85.4 %
Average relationship brokered deposits(1) $ 1,912,099 $ 2,099,652 $ 1,745,144
Average relationship brokered deposits as a percent of average total deposits 5.7 % 6.8 % 6.3 %
Average traditional brokered deposits(1) $ 1,614,643 $ 2,235,359 $ 2,300,901
Average traditional brokered deposits as a percent of average total deposits 4.8 % 7.2 % 8.3 %
(1) Annual averages presented for December 31, 2020.
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We have access to sources of traditional brokered deposits that we estimate to be $7.5 billion. Based on our internal guidelines, we have chosen to limit our use of these sources to a lesser amount.
We have short-term borrowing sources available to supplement deposits and meet our funding needs. Such borrowings are generally used to fund our mortgage finance loans, due to their liquidity, short duration and interest spreads available. These borrowing sources include federal funds purchased from our downstream correspondent bank relationships (which consist of banks that are smaller than our Bank) and from our upstream correspondent bank relationships (which consist of banks that are larger than our Bank), customer repurchase agreements and advances from the FHLB and the Federal Reserve. The following table summarizes our short-term and other borrowings:
(in thousands) March 31, 2021
Federal funds purchased $ 110,100
Repurchase agreements 5,487
FHLB borrowings 2,400,000
Line of credit —
Total short-term borrowings $ 2,515,587
Maximum short-term borrowings outstanding at any month-end during 2021 $ 2,907,202
The following table summarizes our other borrowing capacities net of balances outstanding. As of March 31, 2021, all are scheduled to mature within one year.
(in thousands) March 31, 2021
FHLB borrowing capacity relating to loans $ 7,369,068
FHLB borrowing capacity relating to securities 3,222,022
Total FHLB borrowing capacity(1) $ 10,591,090
Unused federal funds lines available from commercial banks $ 1,055,000
Unused Federal Reserve borrowings capacity $ 2,238,623
Unused revolving line of credit(2) $ 130,000
(1) FHLB borrowings are collateralized by a blanket floating lien on certain real estate secured loans, mortgage finance assets and also certain pledged securities.
(2) Unsecured revolving, non-amortizing line of credit with maturity date of December 14, 2021. Proceeds may be used for general corporate purposes, including funding regulatory capital infusions into the Bank. The loan agreement contains customary financial covenants and restrictions. No borrowings were made against this line of credit during the three months ended March 31, 2021.
Our equity capital averaged $3.0 billion for the three months ended March 31, 2021 as compared to $2.9 billion for the same period in 2020. 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.
Periodically, based on market conditions and other factors, and subject to compliance with applicable laws and regulations and the terms of our existing indebtedness, we or the Bank may repay, repurchase, exchange or redeem outstanding indebtedness, or otherwise enter into transactions regarding our debt or capital structure. For example, we and the Bank periodically evaluate and may engage in liability management transactions, including repurchases or redemptions of outstanding subordinated notes, which may be funded by the issuance of, or exchanges of, newly issued unsecured borrowings, as we seek to actively manage our debt maturity profile and interest cost.
For additional information regarding our capital and stockholders' equity, see Note 7 - Regulatory Restrictions in the accompanying notes to the consolidated financial statements included elsewhere in this report.
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Commitments and Contractual Obligations
The following table presents, as of March 31, 2021, significant fixed and determinable contractual obligations to third parties by payment date. Amounts in the table do not include accrued or accruing interest.
(in thousands) Within One
Year After One But
Within Three
Years After Three
But Within
Five Years After
Five
Years Total
Deposits without a stated maturity $ 31,429,041 $ — $ — $ — $ 31,429,041
Time deposits 1,348,814 609,610 4,500 5 1,962,929
Federal funds purchased and customer repurchase agreements 115,587 — — — 115,587
FHLB borrowings 2,400,000 — — — 2,400,000
Operating lease obligations 17,221 33,169 14,546 21,497 86,433
Long-term debt — — 442,722 222,246 664,968
Total contractual obligations $ 35,310,663 $ 642,779 $ 461,768 $ 243,748 $ 36,658,958
Critical Accounting Policies
SEC guidance requires disclosure of “critical accounting policies.” The SEC defines “critical accounting policies” as those that are most important to the presentation of a company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States. The more significant of these policies are summarized in Note 1 - Operations and Summary of Significant Accounting Policies in the notes to the consolidated financial statements included elsewhere in this report and in our 2020 Form 10-K. Not all significant accounting policies require management to make difficult, subjective or complex judgments. However, the policy noted below could be deemed to meet the SEC’s definition of a critical accounting policy.
Allowance for Credit Losses
Management considers the policies related to the allowance for credit losses as the most critical to the financial statement presentation. The total allowance for credit losses includes activity related to allowances calculated in accordance with Accounting Standards Codification (“ASC”) 326, Credit Losses . The allowance for credit losses is established through a provision for credit losses charged to current earnings. The amount maintained in the allowance reflects management’s continuing evaluation of the 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.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.