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 and results of operations for the three and nine months ended September 30, 2022 and 2021 should be read in conjunction with our audited consolidated financial statements and the related notes to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2021 (the “2021 Form 10-K”). Operating results for the three and nine months ended September 30, 2022 are not necessarily indicative of the results for the year ending December 31, 2022 or any future period.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “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. Forward-looking statements may often be identified by the use of words such as “expects,” “estimates,” “anticipates,” “plans,” “goals,” “objectives,” “intends,” “seeks,” “likely,” “should,” “may” “could” and other similar expressions. These forward-looking statements are based of the historical performance of the Company or on the Company’s current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by the Company that the future plans, estimates or expectations so contemplated will be achieved, and should not be the primary basis upon which investors evaluate an investment in our securities. Certain risks, uncertainties and other factors, including those set forth under “Risk Factors” in Part I, Item 1A of the 2021 Form 10-K and any subsequent Quarterly Report on Form 10-Q or Current Report on Form 8-K may cause actual results to differ materially from the results discussed in the forward-looking statements appearing in this discussion and analysis and may include factors such as, but not limited to, credit quality and risk, the COVID-19 pandemic, industry and technological changes, uncertainties related to our sale of BankDirect Capital Finance, LLC, cyber incidents or other failures, disruptions or security breaches, interest rates, commercial and residential real estate values, economic conditions, including inflation, recession, the threat of recession, and market conditions in Texas, the United States or globally, including governmental and consumer responses to those economic and market conditions, fund availability, accounting estimates and risk management processes, the transition away from the London Interbank Offered Rate (LIBOR), legislative and regulatory changes, ratings or interpretations, business strategy execution, key personnel, competition, mortgage markets, fraud, environmental liability and severe weather, natural disasters, acts of war, terrorism, global conflict or other external events. The Company does not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
Overview of Our Business Operations
On September 6, 2022, we announced the sale of BankDirect Capital Finance (“BDCF” or “disposal group”), our insurance premium finance subsidiary, to AFCO Credit Corporation, an indirect wholly-owned subsidiary of Truist Financial Corp. The sale of BDCF includes its business operations and loan portfolio of approximately $3.1 billion as of September 30, 2022. The sale is an all-cash transaction for a purchase price of approximately $3.4 billion, representing an 8.5% asset premium compared to the value of the purchased loan portfolio as of September 30, 2022. The sale is expected to close in the fourth quarter of 2022, subject to various customary closing conditions. For additional information, see Note 1 - Operations and Summary of Significant Accounting Policies included elsewhere in this report.
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Results of Operations
Selected income statement data and key performance indicators are presented in the table below:
Three months ended September 30, Nine months ended September 30,
(dollars in thousands except per share data) 2022 2021 2022 2021
Net interest income $ 239,080 $ 190,536 $ 628,158 $ 574,805
Provision for credit losses 12,000 5,000 32,000 (20,000)
Non-interest income 25,333 24,779 71,857 106,771
Non-interest expense 197,047 152,987 514,442 452,363
Income before income taxes 55,366 57,328 153,573 249,213
Income tax expense 13,948 13,938 38,346 60,404
Net income 41,418 43,390 115,227 188,809
Preferred stock dividends 4,313 4,312 12,938 14,408
Net income available to common stockholders $ 37,105 $ 39,078 $ 102,289 $ 174,401
Basic earnings per common share $ 0.74 $ 0.77 $ 2.03 $ 3.45
Diluted earnings per common share $ 0.74 $ 0.76 $ 2.00 $ 3.41
Net interest margin 3.05 % 2.11 % 2.64 % 2.06 %
Return on average assets (“ROA”) 0.52 % 0.47 % 0.47 % 0.66 %
Return on average common equity (“ROE”) 5.36 % 5.41 % 4.90 % 8.35 %
Non-interest income to average earning assets 0.33 % 0.27 % 0.30 % 0.38 %
Efficiency ratio(1) 74.5 % 71.1 % 73.5 % 66.4 %
Non-interest expense to average earning assets 2.53 % 1.69 % 2.18 % 1.61 %
(1) Non-interest expense divided by the sum of net interest income and non-interest income.
Three months ended September 30, 2022 compared to three months ended September 30, 2021
We reported net income of $41.4 million and net income available to common stockholders of $37.1 million for the third quarter of 2022, compared to net income of $43.4 million and net income available to common stockholders of $39.1 million for the third quarter of 2021. On a fully diluted basis, earnings per common share were $0.74 for the third quarter of 2022, compared to $0.76 for the third quarter of 2021. ROE was 5.36% and ROA was 0.52% for the third quarter of 2022, compared to 5.41% and 0.47%, respectively, for the third quarter of 2021. The decrease in net income for the third quarter of 2022 compared to the third quarter of 2021 resulted primarily from increases in provision for credit losses and non-interest expense, partially offset by an increase in net interest income.
Nine months ended September 30, 2022 compared to nine months ended September 30, 2021
We reported net income of $115.2 million and net income available to common stockholders of $102.3 million for the nine months ended September 30, 2022, compared to net income of $188.8 million and net income available to common stockholders of $174.4 million for the same period in 2021. On a fully diluted basis, earnings per common share were $2.00 for the nine months ended September 30, 2022, compared to $3.41 for the same period in 2021. ROE was 4.90% and ROA was 0.47% for the nine months ended September 30, 2022, compared to 8.35% and 0.66%, respectively, for the same period in 2021. The decrease in net income for the nine months ended September 30, 2022 compared to the same period in 2021 resulted primarily from a decrease in non-interest income coupled with increases in provision for credit losses and non-interest expense, partially offset by an increase in net interest income.
Details of the changes in the various components of net income are discussed below.
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Taxable Equivalent Net Interest Income Analysis - Quarterly(1)
Three months ended September 30, 2022 Three months ended September 30, 2021
(in thousands except percentages) Average
Balance Income/
Expense Yield/
Rate Average
Balance Income/
Expense Yield/
Rate
Assets
Investment securities(2) $ 3,509,044 $ 15,002 1.58 % $ 3,775,812 $ 10,684 1.12 %
Interest-bearing cash and cash equivalents 4,453,806 24,596 2.19 % 9,046,095 3,606 0.16 %
Loans held for sale 1,029,983 11,316 4.36 % 18,791 54 1.14 %
Loans held for investment, mortgage finance 5,287,531 52,756 3.96 % 7,987,521 58,913 2.93 %
Loans held for investment(3) 16,843,922 218,512 5.15 % 15,266,167 143,864 3.74 %
Less: Allowance for credit losses on loans 229,005 — — 220,984 — —
Loans held for investment, net 21,902,448 271,268 4.91 % 23,032,704 202,777 3.49 %
Total earning assets 30,895,281 322,182 4.10 % 35,873,402 217,121 2.40 %
Cash and other assets 918,630 855,555
Total assets $ 31,813,911 $ 36,728,957
Liabilities and Stockholders’ Equity
Transaction deposits $ 1,444,964 $ 5,239 1.44 % $ 3,012,547 $ 4,737 0.62 %
Savings deposits 10,249,387 46,555 1.80 % 10,044,995 8,262 0.33 %
Time deposits 1,701,238 8,523 1.99 % 1,640,562 1,720 0.42 %
Total interest bearing deposits 13,395,589 60,317 1.79 % 14,698,104 14,719 0.40 %
Short-term borrowings 1,931,537 10,011 2.06 % 2,299,692 748 0.13 %
Long-term debt 921,707 12,663 5.45 % 927,626 10,586 4.53 %
Total interest bearing liabilities 16,248,833 82,991 2.03 % 17,925,422 26,053 0.58 %
Non-interest bearing deposits 12,214,531 15,363,568
Other liabilities 305,554 275,317
Stockholders’ equity 3,044,993 3,164,650
Total liabilities and stockholders’ equity $ 31,813,911 $ 36,728,957
Net interest income $ 239,191 $ 191,068
Net interest margin 3.05 % 2.11 %
Net interest spread 2.07 % 1.82 %
(1) Taxable equivalent rates used where applicable.
(2) Yields on investment securities are calculated using available-for-sale securities at amortized cost.
(3) Average balances included non-accrual loans.
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Taxable Equivalent Net Interest Income Analysis - Year to Date(1)
Nine months ended September 30, 2022 Nine months ended September 30, 2021
(in thousands except percentages) Average
Balance Revenue/
Expense Yield/
Rate Average
Balance Revenue/
Expense Yield/
Rate
Assets
Investment securities(2) $ 3,573,372 $ 47,811 1.69 % $ 3,581,845 $ 32,412 1.20 %
Interest-bearing cash and cash equivalents 5,902,815 37,561 0.85 % 10,814,879 9,500 0.12 %
Loans held for sale 352,325 11,491 4.36 % 117,604 2,430 2.76 %
Loans held for investment, mortgage finance 5,624,712 146,135 3.47 % 7,875,138 181,256 3.08 %
Loans held for investment(3) 16,386,399 531,054 4.33 % 15,321,641 432,777 3.78 %
Less: Allowance for credit losses on loans 217,728 — — 238,996 — —
Loans held for investment, net 21,793,383 677,189 4.15 % 22,957,783 614,033 3.58 %
Total earning assets 31,621,895 774,052 3.25 % 37,472,111 658,375 2.35 %
Cash and other assets 869,867 971,628
Total assets $ 32,491,762 $ 38,443,739
Liabilities and Stockholders’ Equity
Transaction deposits $ 1,846,175 $ 13,122 0.95 % $ 3,596,301 $ 15,993 0.59 %
Savings deposits 9,788,290 70,599 0.96 % 11,400,029 28,040 0.33 %
Time deposits 1,208,213 10,792 1.19 % 1,864,867 6,961 0.50 %
Total interest-bearing deposits 12,842,678 94,513 0.98 % 16,861,197 50,994 0.40 %
Short-term borrowings 1,978,735 15,628 1.06 % 2,443,853 3,842 0.21 %
Long-term debt 926,749 34,651 5.00 % 759,584 27,052 4.76 %
Total interest-bearing liabilities 15,748,162 144,792 1.23 % 20,064,634 81,888 0.55 %
Non-interest bearing deposits 13,391,981 14,978,324
Other liabilities 259,028 286,328
Stockholders’ equity 3,092,591 3,114,453
Total liabilities and stockholders’ equity $ 32,491,762 $ 38,443,739
Net interest income $ 629,260 $ 576,487
Net interest margin 2.64 % 2.06 %
Net interest spread 2.02 % 1.80 %
(4) Taxable equivalent rates used where applicable.
(5) Yields on investment securities are calculated using available-for-sale securities at amortized cost.
(6) Average balances include non-accrual loans
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Volume/Rate Analysis
The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to differences in the average interest rate on those assets and liabilities.
Three months ended September 30, 2022/2021 Nine months ended September 30, 2022/2021
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 $ 4,318 $ (753) $ 5,071 $ 15,399 $ (4) $ 15,403
Interest bearing cash and cash equivalents 20,990 (1,852) 22,842 28,061 (4,368) 32,429
Loans held for sale 11,262 2,906 8,356 9,061 648 8,413
Loans held for investment, mortgage finance loans (6,157) (19,940) 13,783 (35,121) (51,706) 16,585
Loans held for investment 74,648 14,873 59,775 98,277 30,046 68,231
Total 105,061 (4,766) 109,827 115,677 (25,384) 141,061
Interest expense:
Transaction deposits 502 (2,450) 2,952 (2,871) (7,775) 4,904
Savings deposits 38,293 170 38,123 42,559 (3,974) 46,533
Time deposits 6,803 64 6,739 3,831 (2,660) 6,491
Short-term borrowings 9,263 (121) 9,384 11,786 (1,027) 12,813
Long-term debt 2,077 (68) 2,145 7,599 6,255 1,344
Total 56,938 (2,405) 59,343 62,904 (9,181) 72,085
Net interest income $ 48,123 $ (2,361) $ 50,484 $ 52,773 $ (16,203) $ 68,976
(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 $239.1 million for the three months ended September 30, 2022, compared to $190.5 million for the same period in 2021. The increase was primarily due to an increase in yields on average earning assets, partially offset by an increase in funding costs.
Average earning assets for the three months ended September 30, 2022 decreased $5.0 billion compared to the same period in 2021, which included a $4.6 billion decrease in average interest-bearing cash and cash equivalents. The decrease in average interest bearing cash and cash equivalents resulted primarily from our proactive exit of certain high-cost indexed deposit products beginning in the second half of 2021. Average interest-bearing liabilities for the three months ended September 30, 2022 decreased $1.7 billion compared to the same period in 2021, primarily due to a $1.3 billion decrease in average interest-bearing deposits. Average demand deposits for the three months ended September 30, 2022 decreased $3.1 billion compared to the same period in 2021.
Net interest margin for the three months ended September 30, 2022 was 3.05%, compared to 2.11% for the same period in 2021. The increase in net interest margin was primarily due to an increase in yields on average earnings assets and a shift in earning asset composition, partially offset by an increase in funding costs. The increases in yields on earnings assets and cost of funds are attributed to the impact of rising interest rates.
The yield on total loans held for investment increased to 4.91% for the three months ended September 30, 2022, compared to 3.49% for the same period in 2021, and the yield on earning assets increased to 4.10% for the three months ended September 30, 2022, compared to 2.40% for the same period in 2021. Total cost of deposits increased to 0.93% for the three months ended September 30, 2022 from 0.19% for the same period in 2021, and total funding costs, including all deposits, long-term debt and stockholders' equity, increased to 1.04% for the three months ended September 30, 2022, compared to 0.28% for the same period in 2021.
Net interest income was $628.2 million for the nine months ended September 30, 2022, compared to $574.8 million for the same period in 2021. The increase was primarily due to an increase in yields on earnings assets, partially offset by rising funding costs.
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Average earning assets decreased $5.9 billion for the nine months ended September 30, 2022, compared to the same period in 2021, which included a $4.9 billion decrease in average interest-bearing cash and cash equivalents. Average interest-bearing liabilities decreased $4.3 billion for the nine months ended September 30, 2022, compared to the same period in 2021, primarily due to a $4.0 billion decrease in average interest-bearing deposits. Average demand deposits for the nine months ended September 30, 2022 decreased to $13.4 billion from $15.0 billion for the same period in 2021.
Net interest margin for the nine months ended September 30, 2022 was 2.64%, compared to 2.06% for the same period of 2021. The increase was primarily due to the effect of rising interest rates on earning asset yields and a shift in earning asset composition, partially offset by higher funding costs, also as a result of rising interest rates, compared to the same period in 2021.
The yield on total loans held for investment increased to 4.15% for the nine months ended September 30, 2022, compared to 3.58% for the same period in 2021, and the yield on earning assets increased to 3.25% for the nine months ended September 30, 2022, compared to 2.35% for the same period in 2021. Total cost of deposits increased to 0.48% for the nine months ended September 30, 2022 from 0.21% for the same period in 2021 and total funding costs, including all deposits, long-term debt and stockholders' equity, increased to 0.60% for the nine months ended September 30, 2022, compared to 0.29% for the same period in 2021.
Non-interest Income
Three months ended September 30, Nine months ended September 30,
(in thousands) 2022 2021 2022 2021
Service charges on deposit accounts $ 5,701 $ 4,622 $ 17,726 $ 13,972
Wealth management and trust fee income 3,631 3,382 11,594 9,380
Brokered loan fees 3,401 6,032 11,504 22,276
Servicing income 212 292 677 15,236
Investment banking and trading income 7,812 4,127 23,117 17,985
Net gain/(loss) on sale of loans held for sale — (1,185) — 1,317
Other 4,576 7,509 7,239 26,605
Total non-interest income $ 25,333 $ 24,779 $ 71,857 $ 106,771
Non-interest income increased $554,000 during the three months ended September 30, 2022, compared to the same period in 2021. The increase was primarily due to increases in service charges on deposit accounts and investment banking and trading income, as well as the elimination of net losses recorded in the prior year on the sale of loans held for sale, partially offset by decreases in brokered loan fees and other non-interest income.
Non-interest income decreased $34.9 million during the nine months ended September 30, 2022, compared to the same period in 2021. The decrease was primarily due to decreases in brokered loan fees, servicing fee income and net gain/(loss) on sale of loans held for sale all as a result of the sale of our mortgage servicing rights portfolio and transition of the mortgage correspondent aggregation program in 2021, as well as a decrease in other non-interest income.
Non-interest Expense
Three months ended September 30, Nine months ended September 30,
(in thousands) 2022 2021 2022 2021
Salaries and benefits $ 129,336 $ 87,503 $ 333,319 $ 261,855
Occupancy expense 9,433 8,324 27,192 24,463
Marketing 8,282 2,123 21,765 5,720
Legal and professional 16,775 11,055 38,365 28,479
Communications and technology 18,470 28,374 48,819 58,695
FDIC insurance assessment 3,953 4,500 11,252 16,339
Servicing-related expenses — 2,396 — 27,740
Other 10,798 8,712 33,730 29,072
Total non-interest expense $ 197,047 $ 152,987 $ 514,442 $ 452,363
Non-interest expense for the three months ended September 30, 2022 increased $44.1 million compared to the same period in 2021. The third quarter of 2022 included $13.7 million in salaries and benefits expense and $3.0 million in legal and professional expense related to the sale of our insurance premium finance subsidiary. Also contributing to the increase in non-interest expense were increases in salaries and benefits expense, resulting from an increase in headcount, and marketing expense, partially offset by a decrease in communications and technology expense related to the elimination of write-offs of certain software assets recorded in the prior year.
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Non-interest expense increased by $62.1 million during the nine months ended September 30, 2022, compared to the same period in 2021. Year-to-date 2022 expenses included $13.7 million in salaries and benefits expense and $3.0 million in legal and professional expense related to the sale of our insurance premium finance subsidiary. The increase in non-interest expense also included increases in salaries and benefits expense, driven by an increase in headcount, and marketing expense, partially offset by a decrease in servicing-related expenses resulting from the sale of our mortgage servicing rights portfolio in 2021.
Analysis of Financial Condition
Loans Held for Investment
The following table summarizes our loans held for investment by portfolio segment:
September 30, 2022 December 31, 2021
(in thousands)
Commercial $ 8,813,614 $ 9,897,561
Energy 1,106,097 721,373
Mortgage finance 4,908,822 7,475,497
Real estate 5,015,704 4,777,530
Gross loans held for investment $ 19,844,237 $ 22,871,961
Deferred income (net of direct origination costs) (56,456) (65,007)
Total loans held for investment 19,787,781 22,806,954
Allowance for credit losses on loans (234,613) (211,866)
Total loans held for investment, net $ 19,553,168 $ 22,595,088
Total loans held for investment of $19.8 billion at September 30, 2022 decreased $3.0 billion from December 31, 2021, primarily as a result of a $3.1 billion reclassification of our insurance premium finance subsidiary loans from loans held for investment to loans held for sale as of September 30, 2022. Excluding the reclassification of loans held for investment to loans held for sale, we experienced loan growth across all loan categories, except for mortgage finance loans, as we executed on our long-term strategy. 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 25% of total loans held for investment at September 30, 2022, compared to 33% at December 31, 2021. 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. Mortgage finance loan balances have declined as compared to December 31, 2021 as interest rates have continued to rise during 2022.
We originate a substantial majority of all loans held for investment. We also participate in syndicated loan relationships, both as a participant and as an agent. As of September 30, 2022, we had $3.6 billion in syndicated loans, $804.9 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 September 30, 2022, none of our syndicated loans were on non-accrual.
Portfolio Concentrations
Although more than 50% of our total loan exposure is outside of Texas and more than 50% of our deposits are sourced outside of Texas, our Texas concentration remains significant. As of September 30, 2022, 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. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for credit losses.
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Non-performing Assets
Non-performing assets include non-accrual loans and leases and repossessed assets. The table below summarizes our non-performing assets by type and by type of property securing the credit.
(in thousands) September 30, 2022 December 31, 2021
Non-accrual loans held for investment(1):
Commercial:
Assets of the borrowers $ 23,561 $ 18,366
Accounts receivable and inventory 3,337 5,501
Other 1,070 2,045
Total commercial 27,968 25,912
Energy:
Oil and gas properties 6,500 28,380
Total energy 6,500 28,380
Real estate:
Assets of the borrowers — 13,741
Commercial property 1,268 2,840
Single family residences 128 1,629
Total real estate 1,396 18,210
Total non-accrual loans held for investment 35,864 72,502
Non-accrual loans held for sale(2) 1,340 —
Other real estate owned — —
Total non-performing assets $ 37,204 $ 72,502
Non-accrual loans held for investment to total loans held for investment 0.18 % 0.32 %
Total non-performing assets to total assets 0.12 % 0.21 %
Allowance for credit losses on loans to non-accrual loans held for investment 6.5x 2.9x
Loans held for investment past due 90 days and still accruing $ 30,664 $ 3,467
Loans held for investment past due 90 days to total loans held for investment 0.15 % 0.02 %
Loans held for sale past due 90 days and still accruing(2)(3) $ 4,877 $ 3,986
(1) As of September 30, 2022 and December 31, 2021, non-accrual loans include $2.2 million and $19.4 million, respectively, in loans that met the criteria for restructured.
(2) Includes $1.3 million in non-accrual loans and $3.1 million in loans past due 90 days and still accruing associated to our insurance premium finance subsidiary.
(3) Includes loans guaranteed by U.S. government agencies that were repurchased out of Ginnie Mae securities. Loans are recorded as loans held for sale and carried at fair value on the balance sheet. Interest on these past due loans accrues at the debenture rate guaranteed by the U.S. government.
Summary of Credit Loss Experience
The provision for credit losses, comprised of a provision for loans and 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 at each balance sheet date.
We recorded a $32.0 million provision for credit losses for the nine months ended September 30, 2022, compared to a negative provision of $20.0 million for the same period in 2021. The $32.0 million provision for credit losses resulted from updated views on the downside risks to the economic forecast, partially offset by a decline in criticized loans. We recorded $4.9 million in net charge-offs during the nine months ended September 30, 2022, compared to net charge-offs of $11.9 million during the nine months ended September 30, 2021. Criticized loans totaled $484.0 million at September 30, 2022, compared to $582.9 million and $728.9 million at December 31, 2021 and September 30, 2021, respectively. The decrease in criticized loans as compared to June 30, 2022 was primarily due to the resolution of one mortgage finance credit that was downgraded in the second quarter of 2022 and resolved in the third quarter of 2022 with no losses recorded.
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The table below presents key metrics related to our credit loss experience:
September 30, 2022 September 30, 2021
Allowance for credit losses on loans to total loans held for investment 1.19 % 0.93 %
Allowance for credit losses on loans to average total loans held for investment(1) 1.07 % 0.96 %
Total provision for credit losses to average total loans held for investment(1)(2) 0.19 % (0.12) %
Total allowance for credit losses to total loans held for investment 1.30 % 1.01 %
(1) Ratios are calculated using average balance for the nine months ended September 30, 2022 and 2021, respectively.
(2) Ratios are annualized utilizing provision for credit losses for the nine months ended September 30, 2022 and 2021, respectively.
The table below details net charge-offs/(recoveries) as a percentage of average total loans by loan category:
Nine months ended September 30,
2022 2021
Net Charge-offs Net Charge-offs
Net to Average Net to Average
Charge-offs Loans(1) Charge-offs Loans(1)
Commercial $ 2,661 0.03 % $ 5,749 0.08 %
Energy 1,859 0.28 % 5,052 1.01 %
Mortgage finance — — % — — %
Real estate 350 0.01 % 1,080 0.03 %
Total $ 4,870 0.03 % $ 11,881 0.07 %
(1) Interim period ratios are annualized.
Liquidity and Capital Resources
Liquidity
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. Our principal source of funding is customer deposits, supplemented by short-term borrowings, primarily federal funds purchased and Federal Home Loan Banks (“FHLB”) borrowings, which are generally used to fund mortgage finance assets and long-term debt. We also rely on the availability of the mortgage secondary market provided by Ginnie Mae and the government-sponsored enterprises to support the liquidity of our mortgage finance assets.
During 2020 and into the first half of 2021, we significantly increased our interest-bearing cash and cash equivalents to ensure that we had the balance sheet strength to serve our clients during the COVID-19 pandemic. In the second half of 2021 and continuing into the first nine months of 2022, these balances have run off as we have purchased investment securities and proactively exited certain high-cost indexed deposit products. The following table summarizes these balances:
(in thousands except percentage data) September 30, 2022 December 31, 2021 September 30, 2021
Interest bearing cash and cash equivalents $ 3,399,638 $ 7,765,996 $ 8,317,926
Interest bearing cash and cash equivalents as a percent of:
Total loans held for investment 17.2 % 34.1 % 35.0 %
Total earning assets 11.5 % 22.9 % 23.4 %
Total deposits 13.9 % 27.6 % 27.9 %
Our liquidity supports growth in loans held for investment and has 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.
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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 as compared to customer deposits. The following table summarizes our period-end and average core customer deposits, relationship brokered deposits and traditional brokered deposits:
(in thousands) September 30, 2022 December 31, 2021 September 30, 2021
Deposits from core customers $ 23,209,196 $ 25,409,180 $ 27,339,071
Deposits from core customers as a percent of total deposits 94.7 % 90.4 % 91.7 %
Relationship brokered deposits $ 21,799 $ 1,855,892 $ 1,488,066
Relationship brokered deposits as a percent of average total deposits 0.1 % 6.6 % 5.0 %
Traditional brokered deposits $ 1,267,568 $ 844,293 $ 986,531
Traditional brokered deposits as a percent of total deposits 5.2 % 3.0 % 3.3 %
Average deposits from core customers(1) $ 24,705,297 $ 28,734,460 $ 28,930,264
Average deposits from core customers as a percent of average total deposits 94.1 % 91.1 % 90.8 %
Average relationship brokered deposits(1) $ 617,273 $ 1,608,587 $ 1,516,026
Average relationship brokered deposits as a percent of average total deposits 2.4 % 5.1 % 4.8 %
Average traditional brokered deposits(1) $ 912,089 $ 1,188,544 $ 1,393,231
Average traditional brokered deposits as a percent of average total deposits 3.5 % 3.8 % 4.4 %
(1) Annual averages presented for December 31, 2021.
We have access to sources of traditional brokered deposits that we estimate to be $7.5 billion. Based on our internal guidelines, we have currently 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 the outstanding balance of our short-term borrowings, all of which mature within one year:
(in thousands) September 30, 2022 December 31, 2021
Repurchase agreements $ 1,480 2,832
FHLB borrowings 1,700,000 2,200,000
Total short-term borrowings $ 1,701,480 2,202,832
The following table summarizes our short-term borrowing capacities net of balances outstanding.
(in thousands) September 30, 2022 December 31, 2021
FHLB borrowing capacity relating to loans $ 3,078,457 $ 5,190,703
FHLB borrowing capacity relating to securities 3,324,946 3,352,111
Total FHLB borrowing capacity(1) $ 6,403,403 $ 8,542,814
Unused federal funds lines available from commercial banks $ 1,456,000 $ 892,000
Unused Federal Reserve borrowings capacity $ 3,572,804 $ 2,414,702
Unused revolving line of credit(2) $ 75,000 $ 75,000
(1) FHLB borrowings are collateralized by a blanket floating lien on certain real estate secured loans, mortgage finance assets and certain pledged securities.
(2) Unsecured revolving, non-amortizing line of credit with maturity date of February 8, 2023. Proceeds may be used for general corporate purposes, including funding regulatory capital infusions into the Bank. The loan agreement contains customary financial covenants and restrictions. No borrowings were made against this line of credit during the nine months ended September 30, 2022.
We also have long-term debt outstanding of $930.8 million as of September 30, 2022, comprised of trust preferred securities, subordinated notes and senior unsecured credit linked notes with maturity dates ranging from September 2024 to December 2036. The Company may consider raising additional capital, if needed, in public or private offerings of debt or equity securities to supplement deposits and meet our long-term funding needs.
For additional information regarding our borrowings see Note 5 - Short-term Borrowings and Long-term Debt in the accompanying notes to the consolidated unaudited financial statements included elsewhere in this report.
As the Company is a holding company and is a separate operating entity from the Bank, our primary sources of liquidity are dividends received from the Bank and borrowings from outside sources. Banking regulations may limit the amount of dividends that may be paid by the Bank. See Note 7 - Regulatory Ratios and Capital in the accompanying notes to the consolidated unaudited financial statements included elsewhere in this report for additional information regarding dividend restrictions.
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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.
As of September 30, 2022, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us.
Capital Resources
Average total equity was $3.1 billion for the nine months ended September 30, 2022. 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.
On April 19, 2022, our board of directors authorized a new share repurchase program under which we may repurchase up to $150.0 million in shares of our outstanding common stock. Any repurchases under the repurchase program will be made in accordance with applicable securities laws from time to time in open market or private transactions. The extent to which we repurchase shares, and the timing of such repurchases, will be at management’s discretion and will depend upon a variety of factors, including market conditions, our capital position and amount of retained earnings, regulatory requirements and other considerations. No time limit was set for the completion of the share repurchase program, and the program may be suspended or discontinued at any time. During the nine months ended September 30, 2022, the Company repurchased 941,879 shares of its common stock for an aggregate purchase price of $50.0 million, at a weighted average price of $53.11 per share. These repurchases were all made during the second quarter of 2022.
See Note 7 - Regulatory Ratios and Capital in the accompanying notes to the consolidated unaudited financial statements included elsewhere in this report for additional information regarding capital.
Critical Accounting Estimates
SEC guidance requires disclosure of “critical accounting estimates.” The SEC defines “critical accounting estimates” as those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the registrant.
We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States. Certain significant policies are summarized in Note 1 - Operations and Summary of Significant Accounting Policies in the notes to the consolidated unaudited financial statements included elsewhere in this report and in our 2021 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 be highly dependent on estimates, assumptions and judgments that meet the SEC’s definition of a critical accounting estimate.
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 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.
Management considers a range of macroeconomic scenarios in connection with the allowance estimation process. Within the various economic scenarios considered as of September 30, 2022, the quantitative estimate of the allowance for credit loss would increase by approximately $73.0 million under sole consideration of the most severe downside scenario. The quoted
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sensitivity calculation reflects the sensitivity of the modeled allowance estimate to macroeconomic forecast data, but is absent of qualitative overlays and other qualitative adjustments that are part of the quarterly reserving process and does not necessarily reflect the nature and extent of future changes in the allowance for reasons including increases or decreases in qualitative adjustments, changes in the risk profile and size of the portfolio, changes in the severity of the macroeconomic scenario and the range of scenarios under management consideration.
See “ Summary of Credit Loss Experience” above and Note 4 – Loans and Allowance for Credit Losses on Loans in the accompanying notes to the consolidated unaudited financial statements included elsewhere in this report for further discussion of the risk factors considered by management in establishing the allowance for credit losses.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.