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 the Company’s financial condition and results of operations for the six months ended June 30, 2023 and 2022 should be read in conjunction with its audited consolidated financial statements and the related notes to the consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Form 10-K”). Operating results for the three and six months ended June 30, 2023 are not necessarily indicative of the results for the year ending December 31, 2023 or any future period.
Forward-Looking Statements
This report contains “forward-looking statements” within the meaning of and pursuant to the Private Securities Litigation Reform Act of 1995 regarding, among other things, the Company’s financial condition, results of operations, business plans, strategies, future performance and business and industry outlook. These statements are not historical in nature and may often be identified by the use of words such as “believes,” “projects,” “expects,” “may,” “estimates,” “should,” “plans,” “targets,” “intends” “could,” “would,” “anticipates,” “potential,” “confident,” “optimistic” or the negative thereof, or other variations thereon, or comparable terminology, or by discussions of strategy, objectives, estimates, trends, guidance, expectations and future plans.
Because forward-looking statements relate to future results and occurrences, they are subject to inherent and various uncertainties, risks, and changes in circumstances that are difficult to predict, may 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. Numerous risks and other factors, many of which are beyond management’s control, could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. While there can be no assurance that any list of risks is complete, important risk and other factors that could cause actual results to differ materially from those contemplated by forward-looking statements include, but are not limited to, credit quality and risk, the unpredictability of economic and business conditions that may impact the Company or its customers, recent adverse developments in the banking industry highlighted by high-profile bank failures and the potential impact of such developments on customer confidence, liquidity and regulatory responses to these developments, the Company’s ability to effective manage its liquidity risk and any growth plans and the availability of capital and funding, the Company’s ability to effectively manage information technology systems, cyber incidents or other failures, disruptions or security breaches, interest rates, including the impact of rising rates on the Company’s securities portfolio and funding costs, commercial and residential real estate values, adverse or unexpected 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, enforcement actions and regulatory examinations and investigations, ratings or interpretations, business strategy execution, the failure to identify, attract and retain key personnel and other employees, increased or expanded competition from banks and other financial service providers in the Company’s markets, the failure to maintain adequate regulatory capital, environmental liability associated with properties related to the Company’s lending activities, and severe weather, natural disasters, acts of war, terrorism, global conflict, or other external events, climate change and related legislative and regulatory initiatives as well as the risks more fully described in the 2022 10-K, including the “Risk Factors” section in Part I, Item 1A of the 2022 10-K, Quarterly Reports on Form 10-Q, including the “Risk Factors” section in Part II, Item 1A of this report, and in its other documents and filings with the SEC. The information contained in this report speaks only as of its date. Except to the extent required by applicable law or regulation, the Company disclaims any obligation to update such factors or to publicly announce the results of any revisions to any of the forward-looking statements included herein to reflect future events or developments.
Overview
Recent Industry Developments
During the first half of 2023, the banking industry experienced significant volatility with multiple high-profile bank failures and industry wide concerns related to liquidity, deposit outflows, unrealized securities losses and eroding consumer confidence in the banking system. Despite these negative industry developments, the Company’s liquidity position and balance sheet remains robust. The Company’s total deposits increased by 2% as compared to December 31, 2022, to $23.3 billion at June 30, 2023. During the first half of 2023, the Company took a number of preemptive actions, which included pro-active outreach to clients and a robust review of its borrowing and liquidity positions to ensure that the Company is positioned to best serve its clients. Furthermore, the Company’s capital remains at historically high levels with CET1 and Total Capital ratios of 12.2% and 16.4%, respectively, as of June 30, 2023.
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Results of Operations
Selected income statement data and key performance indicators are presented in the table below:
Three Months Ended June 30, Six Months Ended June 30,
(dollars in thousands except per share data) 2023 2022 2023 2022
Net interest income $ 231,990 $ 205,533 $ 467,335 $ 389,079
Provision for credit losses 7,000 22,000 35,000 20,000
Non-interest income 46,011 26,240 83,414 46,523
Non-interest expense 181,644 164,303 375,671 317,395
Income before income taxes 89,357 45,470 140,078 98,207
Income tax expense 20,706 11,311 32,766 24,398
Net income 68,651 34,159 107,312 73,809
Preferred stock dividends 4,312 4,312 8,625 8,625
Net income available to common stockholders $ 64,339 $ 29,847 $ 98,687 $ 65,184
Basic earnings per common share $ 1.34 $ 0.59 $ 2.05 $ 1.29
Diluted earnings per common share $ 1.33 $ 0.59 $ 2.02 $ 1.28
Net interest margin 3.29 % 2.68 % 3.31 % 2.45 %
Return on average assets (“ROA”) 0.95 % 0.44 % 0.74 % 0.45 %
Return on average common equity (“ROE”) 9.17 % 4.35 % 7.15 % 4.67 %
Efficiency ratio(1) 65.3 % 70.9 % 68.2 % 72.9 %
Non-interest income to average earning assets 0.66 % 0.34 % 0.60 % 0.29 %
Non-interest expense to average earning assets 2.61 % 2.16 % 2.69 % 2.00 %
(1) Non-interest expense divided by the sum of net interest income and non-interest income.
Three months ended June 30, 2023 compared to three months ended June 30, 2022
The Company reported net income of $68.7 million and net income available to common stockholders of $64.3 million for the second quarter of 2023, compared to net income of $34.2 million and net income available to common stockholders of $29.8 million for the second quarter of 2022. On a fully diluted basis, earnings per common share were $1.33 for the second quarter of 2023, compared to $0.59 for the same period in 2022. ROE was 9.17% and ROA was 0.95% for the second quarter of 2023, compared to 4.35% and 0.44%, respectively, for the same period in 2022. The increase in net income for the second quarter of 2023 compared to the second quarter of 2022 resulted primarily from increases in net interest income and non-interest income as well as a decrease in provision for credit losses, partially offset by an increase in non-interest expense.
Six months ended June 30, 2023 compared to six months ended June 30, 2022
The Company reported net income of $107.3 million and net income available to common stockholders of $98.7 million for the six months ended June 30, 2023, compared to net income of $73.8 million and net income available to common stockholders of $65.2 million for the same period in 2022. On a fully diluted basis, earnings per common share were $2.02 for the six months ended June 30, 2023, compared to $1.28 for the same period in 2022. ROE was 7.15% and ROA was 0.74% for the six months ended June 30, 2023, compared to 4.67% and 0.45%, respectively, for the same period in 2022. The increase in net income for the six months ended June 30, 2023 compared to the same period in 2022 resulted primarily from increases in net interest income and non-interest income, partially offset by increases in the provision for credit losses and non-interest expense.
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 June 30, 2023 Three Months Ended June 30, 2022
(in thousands except percentages) Average
Balance Income/
Expense Yield/
Rate Average
Balance Income/
Expense Yield/
Rate
Assets
Investment securities(2) $ 4,306,881 $ 27,478 2.36 % $ 3,543,576 $ 15,065 1.60 %
Interest-bearing cash and cash equivalents 3,286,091 41,571 5.07 % 4,747,377 9,394 0.79 %
Loans held for sale 28,414 599 8.46 % 8,123 62 3.07 %
Loans held for investment, mortgage finance 4,376,235 36,198 3.32 % 5,858,599 49,914 3.42 %
Loans held for investment(3) 16,217,314 296,183 7.33 % 16,616,234 168,409 4.07 %
Less: Allowance for credit losses on loans 261,027 — — 211,385 — —
Loans held for investment, net 20,332,522 332,381 6.56 % 22,263,448 218,323 3.93 %
Total earning assets 27,953,908 402,029 5.69 % 30,562,524 242,844 3.16 %
Cash and other assets 1,049,145 870,396
Total assets $ 29,003,053 $ 31,432,920
Liabilities and Stockholders’ Equity
Transaction deposits $ 1,345,742 $ 9,468 2.82 % $ 1,671,729 $ 3,920 0.94 %
Savings deposits 10,590,558 114,275 4.33 % 8,696,819 15,462 0.71 %
Time deposits 1,531,922 13,648 3.57 % 877,399 1,184 0.54 %
Total interest bearing deposits 13,468,222 137,391 4.09 % 11,245,947 20,566 0.73 %
Short-term borrowings 1,397,253 18,253 5.24 % 2,232,119 4,859 0.87 %
Long-term debt 883,871 14,282 6.48 % 929,616 11,393 4.92 %
Total interest bearing liabilities 15,749,346 169,926 4.33 % 14,407,682 36,818 1.02 %
Non-interest bearing deposits 9,749,105 13,747,876
Other liabilities 389,155 227,701
Stockholders’ equity 3,115,447 3,049,661
Total liabilities and stockholders’ equity $ 29,003,053 $ 31,432,920
Net interest income $ 232,103 $ 206,026
Net interest margin 3.29 % 2.68 %
(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)
Six Months Ended June 30, 2023 Six Months Ended June 30, 2022
(dollars in thousands) Average
Balance Revenue /
Expense Yield /
Rate Average
Balance Revenue /
Expense Yield /
Rate
Assets
Investment securities(2) $ 4,184,349 $ 52,770 2.34 % $ 3,606,069 $ 32,808 1.75 %
Interest bearing cash and cash equivalents 4,407,486 104,007 4.76 % 6,639,327 12,965 0.39 %
Loans held for sale 35,902 1,537 8.63 % 7,880 175 4.49 %
Loans held for investment, mortgage finance
3,834,529 64,726 3.40 % 5,796,097 93,380 3.25 %
Loans held for investment(3) 15,909,792 564,314 7.15 % 16,153,845 312,542 3.90 %
Less: Allowance for credit losses on loans 256,900 — — 211,995 — —
Loans held for investment, net
19,487,421 629,040 6.51 % 21,737,947 405,922 3.77 %
Total earning assets 28,115,158 787,354 5.57 % 31,991,223 451,870 2.83 %
Cash and other assets 1,045,466 845,082
Total assets $ 29,160,624 $ 32,836,305
Liabilities and Stockholders’ Equity
Transaction deposits $ 1,062,694 $ 13,321 2.53 % $ 2,050,106 $ 7,882 0.78 %
Savings deposits 10,891,309 219,982 4.07 % 9,553,920 24,045 0.51 %
Time deposits 1,481,569 24,182 3.29 % 957,615 2,269 0.48 %
Total interest bearing deposits 13,435,572 257,485 3.86 % 12,561,641 34,196 0.55 %
Short-term borrowings 1,320,493 32,997 5.04 % 2,002,724 5,617 0.57 %
Long-term debt 907,701 29,265 6.50 % 929,312 21,988 4.77 %
Total interest bearing liabilities 15,663,766 319,747 4.12 % 15,493,677 61,801 0.80 %
Non-interest bearing deposits 10,000,024 13,990,465
Other liabilities 412,758 235,378
Stockholders’ equity 3,084,076 3,116,785
Total liabilities and stockholders’ equity $ 29,160,624 $ 32,836,305
Net interest income $ 467,607 $ 390,069
Net interest margin 3.31 % 2.45 %
(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 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 June 30, 2023/2022 Six Months Ended June 30, 2023/2022
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 $ 12,413 $ 3,045 $ 9,368 $ 19,962 $ 4,887 $ 15,075
Interest bearing cash and cash equivalents 32,177 (2,881) 35,058 91,042 (4,143) 95,185
Loans held for sale 537 155 382 1,362 686 676
Loans held for investment, mortgage finance (13,716) (12,639) (1,077) (28,654) (31,156) 2,502
Loans held for investment 127,774 (4,048) 131,822 251,772 (4,852) 256,624
Total interest income 159,185 (16,368) 175,553 335,484 (34,578) 370,062
Interest expense
Transaction deposits 5,548 (764) 6,312 5,439 (3,459) 8,898
Savings deposits 98,813 3,352 95,461 195,937 3,983 191,954
Time deposits 12,464 881 11,583 21,913 1,287 20,626
Short-term borrowings 13,394 (1,811) 15,205 27,380 (2,032) 29,412
Long-term debt 2,889 (561) 3,450 7,277 (529) 7,806
Total interest expense 133,108 1,097 132,011 257,946 (750) 258,696
Net interest income $ 26,077 $ (17,465) $ 43,542 $ 77,538 $ (33,828) $ 111,366
(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 $232.0 million for the three months ended June 30, 2023, compared to $205.5 million for the same period in 2022. The increase was primarily due to an increase in yields on average earning assets, partially offset by an increase in funding costs and a decrease in average earning assets.
Average earning assets for the three months ended June 30, 2023 decreased $2.6 billion compared to the same period in 2022, which included a $1.5 billion decrease in average interest-bearing cash and cash equivalents and a $1.5 billion decrease in average loans held for investment, mortgage finance. Average interest-bearing liabilities increased $1.3 billion for the three months ended June 30, 2023 compared to the same period in 2022, primarily due to a $2.2 billion increase in average interest-bearing deposits. Average non-interest bearing deposits for the three months ended June 30, 2023 decreased to $9.7 billion from $13.7 billion to the same period in 2022.
Net interest margin for the three months ended June 30, 2023 was 3.29%, compared to 2.68% for the same period in 2022. 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 6.56% for the three months ended June 30, 2023, compared to 3.93% for the same period in 2022, and the yield on earning assets increased to 5.69% for the three months ended June 30, 2023, compared to 3.16% for the same period in 2022. Total cost of deposits increased to 2.37% for the three months ended June 30, 2023 from 0.33% for the same period in 2022, and total funding costs, including non-interest bearing deposits and stockholders' equity, increased to 2.38% for the three months ended June 30, 2023, compared to 0.47% for the same period in 2022.
Net interest income was $467.3 million for the six months ended June 30, 2023, compared to $389.1 million for the same period in 2022. The increase was primarily due to an increase in yields on average earnings assets, partially offset by rising funding costs and a decrease in total average earning assets.
Average earning assets decreased $3.9 billion for the six months ended June 30, 2023, compared to the same period in 2022, which included decreases of $2.2 billion in average interest-bearing cash and cash equivalents and $2.0 million in average loans held for investment, mortgage finance. Average interest-bearing liabilities increased $170.1 million for the six months ended June 30, 2023, compared to the same period in 2022, primarily due to an $873.9 million increase in average interest-bearing deposits partially offset by a $682.2 million decrease in average short-term borrowings. Average non-interest bearing deposits for the six months ended June 30, 2023 decreased to $10.0 billion from $14.0 billion for the same period in 2022.
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Net interest margin for the six months ended June 30, 2023 was 3.31%, compared to 2.45% for the same period of 2022. 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 2022.
The yield on total loans held for investment increased to 6.51% for the six months ended June 30, 2023, compared to 3.77% for the same period in 2022, and the yield on earning assets increased to 5.57% for the six months ended June 30, 2023, compared to 2.83% for the same period in 2022. Total cost of deposits increased to 2.22% for the six months ended June 30, 2023 from 0.26% for the same period in 2022 and total funding costs, including non-interest bearing deposits and stockholders' equity, increased to 2.24% for the six months ended June 30, 2023, compared to 0.38% for the same period in 2022.
Non-interest Income
Three Months Ended June 30, Six Months Ended June 30,
(in thousands) 2023 2022 2023 2022
Service charges on deposit accounts $ 5,158 6,102 $ 10,180 $ 12,217
Wealth management and trust fee income 3,715 4,051 7,144 7,963
Brokered loan fees 2,415 4,133 4,310 8,103
Investment banking and trading income 27,498 11,126 46,266 15,305
Other 7,225 828 15,514 2,935
Total non-interest income $ 46,011 $ 26,240 $ 83,414 $ 46,523
Non-interest income increased $19.8 million during the three months ended June 30, 2023, compared to the same period in 2022. The increase was primarily due to increases in investment banking and trading income and other non-interest income.
Non-interest income increased by $36.9 million during the six months ended June 30, 2023 to $83.4 million, compared to $46.5 million for the same period in 2022. The increase was primarily due to increases in investment banking and trading income and other non-interest income, partially offset by a decrease in brokered loans fees.
Non-interest Expense
Three Months Ended June 30, Six Months Ended June 30,
(in thousands) 2023 2022 2023 2022
Salaries and benefits $ 113,050 $ 103,358 $ 241,720 $ 203,217
Occupancy expense 9,482 8,874 19,101 17,759
Marketing 6,367 8,506 15,411 13,483
Legal and professional 15,669 11,288 30,183 21,590
Communications and technology 20,525 15,649 38,048 30,349
Federal Deposit Insurance Corporation insurance assessment 3,693 3,318 5,863 7,299
Other 12,858 13,310 25,345 23,698
Total non-interest expense $ 181,644 $ 164,303 $ 375,671 $ 317,395
Non-interest expense increased $17.3 million during the six months ended June 30, 2023, compared to the same period in 2022. The increase was primarily due to increases in salaries and benefits, legal and professional and communications and technology expenses, partially offset by a decrease in marketing expense.
Non-interest expense for the six months ended June 30, 2023 increased $58.3 million compared to the same period in 2022, primarily due to increases in salaries and benefits, legal and professional and communications and technology expenses.
Analysis of Financial Condition
Loans Held for Investment
As discussed in Note 1 - Operations and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report, in the second quarter of 2023, changes were made to certain estimates used in the Company’s current expected credit loss model which resulted in adjustments being made to the Company’s portfolio segments. As a result, certain prior period balances below have been reclassified to conform to the current period presentation of portfolio segments.
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The following table summarizes the Company’s loans held for investment by portfolio segment. See Note 1 - Operations and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report for details of these portfolio segments.
(in thousands) June 30, 2023 December 31, 2022
Commercial $ 10,459,640 $ 9,832,676
Mortgage finance 5,098,812 4,090,033
Commercial real estate 5,308,997 4,875,363
Consumer 531,635 552,848
Gross loans held for investment 21,399,084 19,350,920
Unearned income (net of direct origination costs) (73,069) (63,580)
Total loans held for investment $ 21,326,015 $ 19,287,340
Total loans held for investment were $21.3 billion at June 30, 2023, an increase of $2.0 billion from December 31, 2022. The Company experienced broad-based loan growth across all loan categories, except for consumer, as it has continued to execute on its long-term strategy. Mortgage finance loans relate to the mortgage warehouse lending operations in which the Company purchases mortgage loan ownership interests that are typically sold within 10 to 20 days and represent 24% of total loans held for investment at June 30, 2023 compared to 21% at December 31, 2022. Volumes fluctuate based on the level of market demand for the product and the number of days between purchase and sale of the loans, which can be affected by changes in overall market interest rates, and tend to peak at the end of each month.
The Company originates a substantial majority of all loans held for investment. The Company also participates in syndicated loan relationships, both as a participant and as an agent. As of June 30, 2023, the Company had $4.4 billion in syndicated loans, $1.2 billion of which the Company administered as agent. All syndicated loans, whether the Company acts as agent or participant, are underwritten to the same standards as all other loans the Company originates. As of June 30, 2023, $3.0 million of syndicated loans were on non-accrual.
Portfolio Concentrations
Although more than 50% of the Company’s total loan exposure is outside of Texas and more than 50% of deposits are sourced outside of Texas, Texas concentration remains significant. As of June 30, 2023, a majority of the loans held for investment, excluding mortgage finance and other national lines of business, were to businesses with headquarters or operations in Texas. This geographic concentration subjects the Company’s 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 non-accrual loans by portfolio segment and by type of property securing the credit.
(dollars in thousands) June 30, 2023 December 31, 2022
Non-accrual loans held for investment
Commercial:
Business assets $ 76,543 $ 41,448
Oil and gas properties 3,184 3,658
Accounts receivable and inventory 137 1,405
Other — 531
Total commercial 79,864 47,042
Commercial real estate:
Commercial property 175 1,263
Total commercial real estate 175 1,263
Consumer
Single family residences 1,000 —
Other — 33
Total consumer 1,000 33
Total non-accrual loans held for investment $ 81,039 $ 48,338
Non-accrual loans held for sale — —
Other real estate owned (“OREO”) — —
Total non-performing assets $ 81,039 $ 48,338
Non-accrual loans held for investment to total loans held for investment 0.38 % 0.25 %
Total non-performing assets to total assets 0.28 % 0.17 %
Allowance for credit losses on loans to non-accrual loans held for investment 2.9x 5.2x
Loans held for investment past due 90 days and accruing $ 64 $ 131
Loans held for investment past due 90 days to total loans held for investment — % — %
Loans held for sale past due 90 days and accruing $ — $ —
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. Below is a discussion of provision for credit losses on loans. The changes made to the Company’s current expected credit loss model, as discussed above and in Note 1 - Operations and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report, resulted in a reallocation of the allowance for credit losses between loan portfolio segments and allowance balances allocated to off-balance sheet financial instruments. The changes made result in a higher allocation of losses to off-balance sheet financial statements. See Note 6 - Financial Instruments with Off-Balance Sheet Risk in the accompanying notes to the consolidated financial statements included elsewhere in this report for presentation of the activity in the allowance for credit losses for off-balance asset credit losses.
The Company recorded a provision for credit losses on loans of $12.0 million for the six months ended June 30, 2023 compared to a provision of $19.3 million for the six months ended June 30, 2022. The provision for credit losses on loans for the six months ended June 30, 2023 reflects an increase in non-accrual loans and growth in loans held for investment during the six months ended June 30, 2023. The Company recorded $28.1 million in net charge-offs during the six months ended June 30, 2023 compared to $2.1 million in net charge-offs during the same period in 2022. Criticized loans totaled $619.4 million at June 30, 2023, compared to $513.2 million and $603.5 million at December 31, 2022 and June 30, 2022, respectively.
The table below presents key metrics related to the Company’s credit loss experience:
June 30, 2023 June 30, 2022
Allowance for credit losses on loans to total loans held for investment 1.11 % 0.95 %
Allowance for credit losses on loans to average total loans held for investment(1) 1.20 % 1.04 %
Total allowance for credit losses to total loans held for investment 1.32 % 1.03 %
Total provision for credit losses to average total loans held for investment(1)(2) 0.36 % 0.18 %
(1) Ratios are calculated using average balance for the six months ended June 30, 2023 and 2022, respectively.
(2) Ratios are annualized utilizing provision for credit losses for the six months ended June 30, 2023 and 2022, respectively.
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The table below details net charge-offs/(recoveries) as a percentage of average total loans by portfolio segment:
Six Months Ended June 30,
2023 2022
Net
Charge-offs Net Charge-offs
to Average
Loans(1) Net
Charge-offs Net Charge-offs
to Average
Loans(1)
Commercial $ 28,154 0.55 % $ 1,806 0.03 %
Mortgage finance — — % — — %
CRE — — % 350 0.02 %
Consumer (5) — % (19) (0.01) %
Total $ 28,149 0.29 % $ 2,137 0.02 %
(1) Ratios are annualized utilizing net charge-offs for the six months ended June 30, 2023 and 2022, respectively.
Liquidity and Capital Resources
Liquidity
In general terms, liquidity is a measurement of the Company’s ability to meet its cash needs. The Company’s objectives in managing its liquidity are to maintain the ability to meet loan commitments, repurchase investment securities and repay deposits and other liabilities in accordance with their terms, without an adverse impact on current or future earnings. The Company’s liquidity strategy is guided by policies, formulated and monitored by senior management and the Asset and Liability Management Committee (“ALCO”), which take into account the demonstrated marketability of the Company’s assets, the sources and stability of its funding and the level of unfunded commitments. The Company regularly evaluates all of its various funding sources with an emphasis on accessibility, stability, reliability and cost-effectiveness. The Company’s principal source of funding is customer deposits, supplemented by short-term borrowings, primarily from federal funds purchased and Federal Home Loan Bank (“FHLB”) borrowings, which are generally used to fund mortgage finance assets and long-term debt. The Company also relies on the availability of the mortgage secondary market provided by Ginnie Mae and government sponsored entities to support the liquidity of mortgage finance assets.
The following table summarizes the Company’s interest bearing cash and cash equivalents:
(dollars in thousands) June 30, 2023 December 31, 2022
Interest bearing cash and cash equivalents $ 2,587,131 $ 4,778,623
Interest bearing cash and cash equivalents as a percent of:
Total loans held for investment 12.1 % 24.8 %
Total earning assets 9.3 % 17.4 %
Total deposits 11.1 % 20.9 %
Liquidity to support growth in loans held for investment has been fulfilled primarily through growth in customer deposits. The Company’s goal is to obtain as much of its funding for loans held for investment and other earning assets as possible from customer deposits, which are generated principally through development of long-term customer relationships, with a significant focus on treasury management products. As of June 30, 2023, estimated uninsured deposits represented approximately 40% of total deposits. In addition, the Company also has access to deposits through brokered channels. The following table summarizes period-end total deposits:
(dollars in thousands) June 30, 2023 December 31, 2022
Balance % of Total Balance % of Total
Customer deposits $ 21,838,842 93.7 % $ 21,247,999 93.0 %
Brokered deposits 1,479,398 6.3 % 1,608,881 7.0 %
Total deposits $ 23,318,240 100.0 % $ 22,856,880 100.0 %
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The Company has short-term borrowing sources available to supplement deposits and meet its funding needs. Such borrowings are generally used to fund mortgage finance loans, due to their liquidity, short duration and interest spreads available. These borrowing sources include federal funds purchased from downstream correspondent bank relationships (which consist of banks that are smaller than the Bank) and from upstream correspondent bank relationships (which consist of banks that are larger than the Bank), customer repurchase agreements and advances from the FHLB and the Federal Reserve. The following table summarizes short-term borrowings, all of which mature within one year:
(in thousands) June 30, 2023 December 31, 2022
Repurchase agreements $ — $ 1,142
FHLB borrowings 1,350,000 1,200,000
Total short-term and other borrowings $ 1,350,000 $ 1,201,142
The following table summarizes the Company’s short-term borrowing capacities net of balances outstanding:
(in thousands) June 30, 2023 December 31, 2022
FHLB borrowing capacity relating to loans and pledged securities $ 3,253,409 $ 2,621,218
FHLB borrowing capacity relating to unencumbered securities 4,238,418 3,539,297
Total FHLB borrowing capacity(1) $ 7,491,827 $ 6,160,515
Unused federal funds lines available from commercial banks $ 1,458,000 $ 1,479,000
Unused Federal Reserve borrowings capacity $ 3,726,632 $ 3,574,762
Unused revolving line of credit(2) $ 100,000 $ 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, 2024. 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 six months ended June 30, 2023.
The Company has long-term debt outstanding of $857.8 million as of June 30, 2023, comprised of trust preferred securities, subordinated notes and senior unsecured credit linked notes with maturity dates ranging from September 2024 to December 2036. In the second quarter of 2023, the Company partially paid down $75.0 million of the senior unsecured credit-linked notes in accordance with the terms of the notes. See Note 5 - Short-Term Borrowings and Long-Term Debt in the accompanying notes to the consolidated financial statements included elsewhere in this report for additional information. The Company may consider raising additional capital, if needed, in public or private offerings of debt or equity securities to supplement deposits and meet its long-term funding needs.
As the Company is a holding company and is a separate operating entity from the Bank, the Company’s 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 financial statements included elsewhere in this report for additional information regarding dividend restrictions and “Liquidity Risks” included in Part I, Item 1A of the 2022 Form 10-K.
Periodically, based on market conditions and other factors, and subject to compliance with applicable laws and regulations and the terms of its existing indebtedness, the Company may repay, repurchase, exchange or redeem outstanding indebtedness, or otherwise enter into transactions regarding debt or capital structure. For example, the Company periodically evaluates 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 to actively manage the debt maturity profile and interest cost.
Capital Resources
The Company’s equity capital averaged $3.1 billion for the six months ended June 30, 2023 compared to $3.1 billion for the same period in 2022. The Company has not paid any cash dividends on common stock since operations commenced and has no plans to do so in the foreseeable future.
In January 2023, the Company completed the full $150.0 million of share repurchases authorized by the Company’s board of directors on April 19, 2022. On January 18, 2023, the Company’s board of directors authorized a new share repurchase program under which the Company may repurchase up to $150.0 million in shares of outstanding common stock. Any repurchases under the repurchase program have been made in accordance with applicable securities laws in open market or private transactions. The extent to which the Company repurchases shares, and the timing of such repurchases, will be at management’s discretion and will depend upon a variety of factors, including market conditions, 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 six months ended June 30, 2023, the Company repurchased 1,011,909 shares of its common stock for an aggregate purchase price of $59.7 million, at a weighted average price of $58.98 per share. The aggregate purchase price and weighted average price per share does not include the effect of excise tax expense incurred on net stock repurchases.
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For additional information on the Company’s capital and stockholders’ equity, see Note 7 - Regulatory Ratios and Capital in the accompanying notes to the consolidated financial statements included elsewhere in this report.
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.
The Company follows 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 the Company’s 2022 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 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 the Company’s 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. The allowance for credit losses on off-balance sheet financial instruments is recorded in other liabilities on the consolidated balance sheets. For purposes of determining the allowance for credit losses, the loan portfolio is segregated into pools first by portfolio segment and then by past due status or credit grade. Each pool is assigned a loss estimate, reflecting historical loss rates that incorporate probability of default and severity of losses over the estimated remaining life of the loans. Loans that do not share risk characteristics are evaluated on an individual basis and are not included in the collective (pool) 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. Modifications to loss estimates are made to incorporate a reasonable and supportable forecast of future losses at the pool level, as well as any necessary qualitative adjustments using a Portfolio Level Qualitative Factor (“PLQF”) and/or a Portfolio Segment Level Qualitative Factor (“SLQF”). A similar process is employed to calculate a reserve assigned to off-balance sheet financial instruments, specifically unfunded loan commitments and letters of credit. Modified loss estimates are assigned based on the balance of the commitments estimated to be outstanding at the time of default. 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 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.
Management considers a range of macroeconomic scenarios in connection with the allowance estimation process. Within the various economic scenarios considered as of June 30, 2023, the quantitative estimate of the allowance for credit loss would increase by approximately $153.3 million under sole consideration of the most severe downside scenario. The quoted 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.
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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.