Edgar Filing: CULLEN/FROST BANKERS, INC.

2015.03.31 10Q

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United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: March 31, 2015

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission file number: 001-13221

Cullen/Frost Bankers, Inc.

(Exact name of registrant as specified in its charter)



Texas	74-1751768
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

100 W. Houston Street, San Antonio, Texas	78205
(Address of principal executive offices)	(Zip code)

(210) 220-4011

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	ý	Accelerated filer	¨
Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No ý

As of April 22, 2015 there were 63,177,648 shares of the registrant’s Common Stock, $.01 par value, outstanding.

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Cullen/Frost Bankers, Inc.

Quarterly Report on Form 10-Q

March 31, 2015

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		Page
Part I - Financial Information
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets	3
	Consolidated Statements of Income	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Changes in Shareholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Consolidated Financial Statements	8
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	43
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	61
Item 4.	Controls and Procedures	62

Part II - Other Information
Item 1.	Legal Proceedings	63
Item 1A.	Risk Factors	63
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	63
Item 3.	Defaults Upon Senior Securities	63
Item 4.	Mine Safety Disclosures	63
Item 5.	Other Information	63
Item 6.	Exhibits	63

Signatures		64

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Part I. Financial Information

Item 1. Financial Statements (Unaudited)

Cullen/Frost Bankers, Inc.

Consolidated Balance Sheets

(Dollars in thousands, except per share amounts)



	March 31, 2015			December 31, 2014
Assets:
Cash and due from banks	$	639,575		$	702,485
Interest-bearing deposits	3,175,572			3,630,846
Federal funds sold and resell agreements	29,617			30,792
Total cash and cash equivalents	3,844,764			4,364,123
Securities held to maturity, at amortized cost	2,817,511			2,926,486
Securities available for sale, at estimated fair value	8,672,497			8,461,254
Trading account securities	15,662			15,426
Loans, net of unearned discounts	11,214,813			10,987,535
Less: Allowance for loan losses	(105,708		)	(99,542		)
Net loans	11,109,105			10,887,993
Premises and equipment, net	487,490			442,170
Goodwill	654,668			654,668
Other intangible assets, net	11,231			12,125
Cash surrender value of life insurance policies	172,936			172,050
Accrued interest receivable and other assets	373,118			341,480
Total assets	$	28,158,982		$	28,277,775

Liabilities:
Deposits:
Non-interest-bearing demand deposits	$	10,031,950		$	10,149,061
Interest-bearing deposits	14,117,672			13,986,869
Total deposits	24,149,622			24,135,930
Federal funds purchased and repurchase agreements	604,207			803,119
Junior subordinated deferrable interest debentures	137,115			137,115
Other long-term borrowings	100,000			100,000
Accrued interest payable and other liabilities	257,107			250,208
Total liabilities	25,248,051			25,426,372

Shareholders’ Equity:
Preferred stock, par value $0.01 per share; 10,000,000 shares authorized; 6,000,000 Series A shares ($25 liquidation preference) issued at March 31, 2015 and December 31, 2014	144,486			144,486
Common stock, par value $0.01 per share; 210,000,000 shares authorized; 63,632,464 shares issued at March 31, 2015 and December 31, 2014	637			637
Additional paid-in capital	889,112			886,476
Retained earnings	1,747,958			1,710,324
Accumulated other comprehensive income, net of tax	160,119			141,814
Treasury stock, at cost; 468,691 shares at March 31, 2015 and 483,041 shares at December 31, 2014	(31,381		)	(32,334		)
Total shareholders’ equity	2,910,931			2,851,403
Total liabilities and shareholders’ equity	$	28,158,982		$	28,277,775

See Notes to Consolidated Financial Statements.

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Cullen/Frost Bankers, Inc.

Consolidated Statements of Income

(Dollars in thousands, except per share amounts)



	Three Months Ended March 31,
	2015		2014
Interest income:
Loans, including fees	$	105,666	$	104,315
Securities:
Taxable	30,172		21,403
Tax-exempt	46,546		35,564
Interest-bearing deposits	1,970		2,404
Federal funds sold and resell agreements	20		20
Total interest income	184,374		163,706
Interest expense:
Deposits	2,756		2,561
Federal funds purchased and repurchase agreements	36		27
Junior subordinated deferrable interest debentures	655		561
Other long-term borrowings	224		222
Total interest expense	3,671		3,371
Net interest income	180,703		160,335
Provision for loan losses	8,162		6,600
Net interest income after provision for loan losses	172,541		153,735
Non-interest income:
Trust and investment management fees	27,161		25,411
Service charges on deposit accounts	19,777		19,974
Insurance commissions and fees	14,635		13,126
Interchange and debit card transaction fees	4,643		4,243
Other charges, commissions and fees	8,441		8,207
Net gain (loss) on securities transactions	228		—
Other	8,330		6,529
Total non-interest income	83,215		77,490
Non-interest expense:
Salaries and wages	76,072		70,217
Employee benefits	20,227		17,388
Net occupancy	15,081		12,953
Furniture and equipment	15,534		14,953
Deposit insurance	3,613		3,117
Intangible amortization	894		689
Other	40,090		38,624
Total non-interest expense	171,511		157,941
Income before income taxes	84,245		73,284
Income taxes	12,082		12,096
Net income	72,163		61,188
Preferred stock dividends	2,016		2,016
Net income available to common shareholders	$	70,147	$	59,172

Earnings per common share:
Basic	$	1.11	$	0.97
Diluted	1.10		0.96

See Notes to Consolidated Financial Statements.

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Cullen/Frost Bankers, Inc.

Consolidated Statements of Comprehensive Income

(Dollars in thousands)



	Three Months Ended March 31,
	2015			2014
Net income	$	72,163		$	61,188
Other comprehensive income (loss), before tax:
Securities available for sale and transferred securities:
Change in net unrealized gain/loss during the period	34,527			21,431
Change in net unrealized gain on securities transferred to held to maturity	(7,887		)	(9,198		)
Reclassification adjustment for net (gains) losses included in net income	(228		)	—
Total securities available for sale and transferred securities	26,412			12,233
Defined-benefit post-retirement benefit plans:
Change in the net actuarial gain/loss	1,749			672
Derivatives:
Reclassification adjustment for gains on interest rate swaps on variable-rate loans included in net income	—			(9,345		)
Other comprehensive income (loss), before tax	28,161			3,560
Deferred tax expense (benefit) related to other comprehensive income	9,856			1,246
Other comprehensive income (loss), net of tax	18,305			2,314
Comprehensive income	$	90,468		$	63,502

See Notes to Consolidated Financial Statements.

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Cullen/Frost Bankers, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

(Dollars in thousands, except per share amounts)



	Three Months Ended March 31,
	2015			2014
Total shareholders’ equity at beginning of period	$	2,851,403		$	2,514,161
Net income	72,163			61,188
Other comprehensive income (loss)	18,305			2,314
Stock option exercises (14,350 shares in 2015 and 329,825 shares in 2014)	728			17,279
Stock compensation expense recognized in earnings	2,562			2,136
Tax benefits related to stock compensation	74			1,344
Cash dividends – preferred stock (approximately $0.34 per share in both 2015 and in 2014)	(2,016		)	(2,016		)
Cash dividends – common stock ($0.51 per share in 2015 and $0.50 per share in 2014)	(32,288		)	(30,487		)
Total shareholders’ equity at end of period	$	2,910,931		$	2,565,919

See Notes to Consolidated Financial Statements.

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Cullen/Frost Bankers, Inc.

Consolidated Statements of Cash Flows

(Dollars in thousands)



	Three Months Ended March 31,
	2015			2014
Operating Activities:
Net income	$	72,163		$	61,188
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses	8,162			6,600
Deferred tax expense (benefit)	(3,748		)	(1,933		)
Accretion of loan discounts	(3,571		)	(3,503		)
Securities premium amortization (discount accretion), net	17,308			13,810
Net (gain) loss on securities transactions	(228		)	—
Depreciation and amortization	9,989			9,702
Net (gain) loss on sale/write-down of assets/foreclosed assets	(779		)	147
Stock-based compensation	2,562			2,136
Net tax benefit (deficiency) from stock-based compensation	(1		)	9
Excess tax benefits from stock-based compensation	(75		)	(1,335		)
Earnings on life insurance policies	(886		)	(682		)
Net change in:
Trading account securities	(236		)	909
Accrued interest receivable and other assets	(36,459		)	14,633
Accrued interest payable and other liabilities	(9,423		)	(29,098		)
Net cash from operating activities	54,778			72,583

Investing Activities:
Securities held to maturity:
Purchases	—			—
Maturities, calls and principal repayments	95,453			42,113
Securities available for sale:
Purchases	(772,500		)	(617,914		)
Sales	223,987			—
Maturities, calls and principal repayments	372,316			1,163,981
Net change in loans	(225,770		)	(237,216		)
Net cash (paid) received in acquisitions	—			—
Proceeds from sales of premises and equipment	—			15
Purchases of premises and equipment	(51,803		)	(13,215		)
Proceeds from sales of repossessed properties	2,901			1,719
Net cash from investing activities	(355,416		)	339,483

Financing Activities:
Net change in deposits	13,692			376,847
Net change in short-term borrowings	(198,912		)	(153,018		)
Proceeds from stock option exercises	728			17,279
Excess tax benefits from stock-based compensation	75			1,335
Cash dividends paid on preferred stock	(2,016		)	(2,016		)
Cash dividends paid on common stock	(32,288		)	(30,487		)
Net cash from financing activities	(218,721		)	209,940

Net change in cash and cash equivalents	(519,359		)	622,006
Cash and equivalents at beginning of period	4,364,123			4,556,125
Cash and equivalents at end of period	$	3,844,764		$	5,178,131

See Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements

(Table amounts in thousands, except for share and per share amounts)

Note 1 - Significant Accounting Policies

Nature of Operations. Cullen/Frost Bankers, Inc. (“Cullen/Frost”) is a financial holding company and a bank holding company headquartered in San Antonio, Texas that provides, through our subsidiaries, a broad array of products and services throughout numerous Texas markets. In addition to general commercial and consumer banking, other products and services offered include trust and investment management, investment banking, insurance, brokerage, leasing, treasury management and item processing.

Basis of Presentation. The consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of Cullen/Frost and all other entities in which Cullen/Frost has a controlling financial interest. All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and financial reporting policies we follow conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry.

The consolidated financial statements in this Quarterly Report on Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of our financial position and results of operations. All such adjustments were of a normal and recurring nature. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2014, included in our Annual Report on Form 10-K filed with the SEC on February 5, 2015 (the “2014 Form 10-K”). Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for loan losses and the fair values of financial instruments and the status of contingencies are particularly subject to change.

Cash Flow Reporting. Additional cash flow information was as follows:



	Three Months Ended March 31,
	2015		2014
Cash paid for interest	$	3,639	$	3,495
Cash paid for income taxes	—		—
Significant non-cash transactions:
Securities purchased not yet settled	12,192		119,155
Loans foreclosed and transferred to other real estate owned and foreclosed assets	67		1,994
Loans to facilitate the sale of other real estate owned	—		102

Reclassifications and Restatements. Certain items in prior financial statements have been reclassified to conform to the current presentation. Additionally, certain items in prior financial statements have been restated to reflect adjustments to initially reported provisional amounts recognized in business combinations so that the prior financial statements are reported as if the adjusted amounts had been known as of the measurement date of the business combination. In that regard, during 2015, we made acquisition valuation adjustments impacting certain assets acquired in connection with the acquisition of WNB Bancshares, Inc. (See Note 2 - Mergers and Acquisitions). As a result of these adjustments, our consolidated balance sheet as of December 31, 2014 reflects a $718 thousand increase in goodwill and a $718 thousand decrease in premises and equipment when compared to previously reported amounts.

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Note 2 - Mergers and Acquisitions

On May 30, 2014, we acquired WNB Bancshares, Inc. ("WNB"), including its subsidiary Western National Bank ("Western"), a privately-held bank holding company and bank located in the Permian Basin region of Texas. We purchased all of the outstanding shares of WNB for approximately $198.8 million. The total purchase price included $149.7 million of our common stock (2 million shares) and $49.1 million in cash. Western was integrated into Frost Bank as of the close of business on June 20, 2014.

The acquisition of WNB was accounted for using the acquisition method with all cash consideration funded through internal sources. The operating results of WNB are included with our results of operations since the date of acquisition. The total purchase price paid for the acquisition of WNB was allocated based on the estimated fair values of the assets acquired and liabilities assumed as set forth below. The purchase price allocation is preliminary and is subject to final determination and valuation of the fair value of assets acquired and liabilities assumed.



Cash and cash equivalents	$	879,740
Securities available for sale	154,227
Loans	670,619
Premises and equipment	22,135
Core deposit intangible asset	9,300
Goodwill	118,019
Other assets	33,644
Deposits	(1,624,043		)
Other borrowings	(63,592		)
Other liabilities	(1,251		)
	$	198,798

The loans acquired in this transaction were recorded at fair value with no carryover of any existing allowance for loan losses. Loans that were not deemed to be credit impaired at acquisition were subsequently considered as a part of our determination of the adequacy of the allowance for loan losses. Purchased credit-impaired loans, meaning those loans with evidence of credit quality deterioration at acquisition, were not significant. The core deposit intangible asset acquired in this transaction will be amortized using an accelerated method over a period of 10 years. Pro forma condensed consolidated results of operations assuming WNB had been acquired at the beginning of the reported periods are not presented because the effect of this acquisition was not considered significant based on the SEC significance tests.

Expenditures related to the acquisition of WNB totaled $1.1 million during the three months ended March 31, 2014 and are reported as a component of other non-interest expense in the accompanying consolidated income statements.

As part of the approval process in connection with the acquisition of WNB, we agreed with the Federal Reserve that before bringing it any further expansionary proposals, we would enhance certain compliance programs, including those related to fair lending. We are currently working on these enhancements.

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Note 3 - Securities

A summary of the amortized cost and estimated fair value of securities, excluding trading securities, is presented below.



	March 31, 2015								December 31, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Held to Maturity
U.S. Treasury	$	249,115	$	14,030	$	—	$	263,145	$	249,009	$	14,604	$	—	$	263,613
Residential mortgage-backed securities	7,499		113		—		7,612		8,012		92		—		8,104
States and political subdivisions	2,559,547		43,007		7,957		2,594,597		2,668,115		34,243		9,035		2,693,323
Other	1,350		—		—		1,350		1,350		—		—		1,350
Total	$	2,817,511	$	57,150	$	7,957	$	2,866,704	$	2,926,486	$	48,939	$	9,035	$	2,966,390
Available for Sale
U.S. Treasury	$	3,711,872	$	64,203	$	1,998	$	3,774,077	$	3,783,899	$	30,594	$	3,241	$	3,811,252
Residential mortgage-backed securities	1,256,377		67,713		377		1,323,713		1,331,114		68,027		417		1,398,724
States and political subdivisions	3,428,238		107,136		3,071		3,532,303		3,104,563		104,500		156		3,208,907
Other	42,404		—		—		42,404		42,371		—		—		42,371
Total	$	8,438,891	$	239,052	$	5,446	$	8,672,497	$	8,261,947	$	203,121	$	3,814	$	8,461,254

All mortgage-backed securities included in the above table were issued by U.S. government agencies and corporations. At March 31, 2015, approximately 97.5% of the securities in our municipal bond portfolio were issued by political subdivisions or agencies within the State of Texas, of which approximately 64.1% are either guaranteed by the Texas Permanent School Fund, which has a “triple A” insurer financial strength rating, or secured by U.S. Treasury securities via defeasance of the debt by the issuers. Securities with limited marketability, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are carried at cost and are reported as other available for sale securities in the above table. The carrying value of securities pledged to secure public funds, trust deposits, repurchase agreements and for other purposes, as required or permitted by law was $3.1 billion at March 31, 2015 and $3.0 billion and December 31, 2014.

During the fourth quarter of 2012, we reclassified certain securities from available for sale to held to maturity. The securities had an aggregate fair value of $2.3 billion with an aggregate net unrealized gain of $165.7 million ($107.7 million, net of tax) on the date of the transfer. The net unamortized, unrealized gain on the transferred securities included in accumulated other comprehensive income in the accompanying balance sheet as of March 31, 2015 totaled $86.0 million ($55.9 million, net of tax). This amount will be amortized out of accumulated other comprehensive income over the remaining life of the underlying securities as an adjustment of the yield on those securities.

As of March 31, 2015, securities with unrealized losses, segregated by length of impairment, were as follows:



	Less than 12 Months				More than 12 Months				Total
	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
Held to Maturity
States and political subdivisions	$	227,355	$	1,163	$	296,614	$	6,794	$	523,969	$	7,957
Total	$	227,355	$	1,163	$	296,614	$	6,794	$	523,969	$	7,957
Available for Sale
U.S. Treasury	$	526,222	$	1,998	$	—	$	—	$	526,222	$	1,998
Residential mortgage-backed securities	8,360		95		12,398		282		20,758		377
States and political subdivisions	286,513		3,071		—		—		286,513		3,071
Total	$	821,095	$	5,164	$	12,398	$	282	$	833,493	$	5,446

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Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost.

Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time we will receive full value for the securities. Furthermore, as of March 31, 2015, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that we will not have to sell any such securities before a recovery of cost. Any unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of March 31, 2015, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in our consolidated income statement.

The amortized cost and estimated fair value of securities, excluding trading securities, at March 31, 2015 are presented below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Residential mortgage-backed securities and equity securities are shown separately since they are not due at a single maturity date.



	Held to Maturity				Available for Sale
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Due in one year or less	$	186,337	$	191,861	$	14,228	$	14,542
Due after one year through five years	491,938		523,304		3,110,546		3,146,176
Due after five years through ten years	220,730		222,875		1,718,927		1,778,335
Due after ten years	1,911,007		1,921,052		2,296,409		2,367,327
Residential mortgage-backed securities	7,499		7,612		1,256,377		1,323,713
Equity securities	—		—		42,404		42,404
Total	$	2,817,511	$	2,866,704	$	8,438,891	$	8,672,497

Sales of securities available for sale were as follows:



	Three Months Ended March 31,
	2015			2014
Proceeds from sales	$	223,987		$	—
Gross realized gains	228			—
Gross realized losses	—			—
Tax (expense) benefit of securities gains/losses	(80		)	—

Premium amortization and discount accretion included in interest income on securities was as follows:



	Three Months Ended March 31,
	2015			2014
Premium amortization	$	(20,006	)	$	(15,396	)
Discount accretion	2,698			1,586
Net (premium amortization) discount accretion	$	(17,308	)	$	(13,810	)

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Trading account securities, at estimated fair value, were as follows:



	March 31, 2015		December 31, 2014
U.S. Treasury	$	12,833	$	15,339
States and political subdivisions	2,829		87
Total	$	15,662	$	15,426

Net gains and losses on trading account securities were as follows:



	Three Months Ended March 31,
	2015			2014
Net gain on sales transactions	$	280		$	240
Net mark-to-market gains (losses)	(14		)	(3		)
Net gain (loss) on trading account securities	$	266		$	237

Note 4 - Loans

Loans were as follows:



	March 31, 2015			Percentage of Total		December 31, 2014			Percentage of Total
Commercial and industrial:
Commercial	$	5,582,282		49.8	%	$	5,429,206		49.4	%
Leases	326,253			2.9		338,537			3.1
Total commercial and industrial	5,908,535			52.7		5,767,743			52.5
Commercial real estate:
Commercial mortgages	3,095,830			27.6		3,080,202			28.0
Construction	685,629			6.1		629,988			5.7
Land	292,966			2.6		291,907			2.7
Total commercial real estate	4,074,425			36.3		4,002,097			36.4
Consumer real estate:
Home equity loans	338,732			3.0		342,725			3.1
Home equity lines of credit	222,967			2.0		220,128			2.0
Other	290,704			2.6		286,198			2.6
Total consumer real estate	852,403			7.6		849,051			7.7
Total real estate	4,926,828			43.9		4,851,148			44.1
Consumer and other:
Consumer installment	395,879			3.5		385,479			3.5
Other	7,239			0.1		8,122			0.1
Total consumer and other	403,118			3.6		393,601			3.6
Unearned discounts	(23,668		)	(0.2	)	(24,957		)	(0.2	)
Total loans	$	11,214,813		100.0	%	$	10,987,535		100.0	%

Loan Origination/Risk Management. We have certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, our management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may

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be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing our commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce our exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, we avoid financing single-purpose projects unless other underwriting factors are present to help mitigate risk. We also utilize third-party experts to provide insight and guidance about economic conditions and trends affecting market areas we serve. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2015, approximately 54.0% of the outstanding principal balance of our commercial real estate loans were secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties that we may originate from time to time, we generally require the borrower to have had an existing relationship with us and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from us until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

We originate consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

We maintain an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.

Concentrations of Credit. Most of our lending activity occurs within the State of Texas, including the four largest metropolitan areas of Austin, Dallas/Ft. Worth, Houston and San Antonio, as well as other markets. The majority of our loan portfolio consists of commercial and industrial and commercial real estate loans. As of March 31, 2015, there were no concentrations of loans related to any single industry in excess of 10% of total loans other than energy loans, which totaled 16.2% of total loans.

Foreign Loans. We have U.S. dollar denominated loans and commitments to borrowers in Mexico. The outstanding balance of these loans and the unfunded amounts available under these commitments were not significant at March 31, 2015 or December 31, 2014.

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. In determining whether or not a borrower may be unable to meet payment obligations for each class of loans, we consider the borrower’s debt service capacity through the analysis of current financial information, if available, and/or current information with regards to our collateral position. Regulatory provisions would typically require the placement of a loan on non-accrual status if (i) principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection or (ii) full payment of principal and interest is not expected. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income on non-accrual loans is recognized only to the extent that cash payments are received in excess of principal due. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and

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future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.

Non-accrual loans, segregated by class of loans, were as follows:



	March 31, 2015		December 31, 2014
Commercial and industrial:
Energy	$	636	$	636
Other commercial	32,965		34,108
Commercial real estate:
Buildings, land and other	17,145		19,639
Construction	2,740		2,792
Consumer real estate	2,347		2,212
Consumer and other	481		538
Total	$	56,314	$	59,925

As of March 31, 2015, non-accrual loans reported in the table above included $613 thousand related to loans that were restructured as “troubled debt restructurings” during 2015. See the section captioned “Troubled Debt Restructurings” elsewhere in this note. Had non-accrual loans performed in accordance with their original contract terms, we would have recognized additional interest income, net of tax, of approximately $397 thousand for the three months ended March 31, 2015, compared to $358 thousand for three months ended March 31, 2014.

An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of March 31, 2015 was as follows:



	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Current Loans			Total Loans			Accruing Loans 90 or More Days Past Due
Commercial and industrial:
Energy	$	1,000	$	4,538	$	5,538	$	1,813,511		$	1,819,049		$	3,902
Other commercial	23,685		25,431		49,116		4,040,370			4,089,486			6,078
Commercial real estate:
Buildings, land and other	13,405		7,005		20,410		3,368,386			3,388,796			1,278
Construction	1,371		50		1,421		684,208			685,629			50
Consumer real estate	5,670		1,961		7,631		844,772			852,403			1,662
Consumer and other	4,096		721		4,817		398,301			403,118			669
Unearned discounts	—		—		—		(23,668		)	(23,668		)	—
Total	$	49,227	$	39,706	$	88,933	$	11,125,880		$	11,214,813		$	13,639

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable we will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectibility of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Regulatory guidelines require us to reevaluate the fair value of collateral supporting impaired collateral dependent loans on at least an annual basis. While our policy is to comply with the regulatory guidelines, our general practice is to reevaluate the fair value of collateral supporting impaired collateral dependent loans on a quarterly basis. Thus, appraisals are never considered to be outdated, and we do not need to make any adjustments to the appraised values. The fair value of collateral supporting impaired collateral dependent loans is evaluated by our internal appraisal services using a methodology that is consistent with the Uniform Standards of Professional Appraisal Practice. The fair value of collateral supporting impaired collateral dependent construction loans is based on an “as is” valuation.

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Impaired loans are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired.



	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance
March 31, 2015
Commercial and industrial:
Energy	$	705	$	636	$	—	$	636	$	—
Other commercial	42,262		28,275		2,720		30,995		1,404
Commercial real estate:
Buildings, land and other	20,257		14,723		197		14,920		71
Construction	3,004		2,740		—		2,740		—
Consumer real estate	789		568		—		568		—
Consumer and other	—		—		—		—		—
Total	$	67,017	$	46,942	$	2,917	$	49,859	$	1,475
December 31, 2014
Commercial and industrial:
Energy	$	706	$	636	$	—	$	636	$	—
Other commercial	42,212		29,007		2,853		31,860		1,613
Commercial real estate:
Buildings, land and other	22,919		17,441		265		17,706		67
Construction	3,007		2,793		—		2,793		—
Consumer real estate	812		596		—		596		—
Consumer and other	—		—		—		—		—
Total	$	69,656	$	50,473	$	3,118	$	53,591	$	1,680

The average recorded investment in impaired loans was as follows:



	Three Months Ended March 31,
	2015		2014
Commercial and industrial:
Energy	$	636	$	529
Other commercial	31,428		20,866
Commercial real estate:
Buildings, land and other	16,313		22,798
Construction	2,767		156
Consumer real estate	582		732
Consumer and other	—		271
Total	$	51,726	$	45,352

Troubled Debt Restructurings. The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules, reductions in collateral and other actions intended to minimize potential losses.

Troubled debt restructurings during the three months ended March 31, 2015 and March 31, 2014 are set forth in the following table.



	Three Months Ended March 31, 2015				Three Months Ended March 31, 2014
	Balance at Restructure		Balance at Period-End		Balance at Restructure		Balance at Period-End
Commercial and industrial:
Energy	$	—	$	—	$	—	$	—
Other commercial	709		613		819		793
	$	709	$	613	$	819	$	793

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The modifications during the reported periods primarily related to extending amortization periods, converting the loans to interest only for a limited period of time, consolidating notes and/or reducing collateral or interest rates. The modifications did not significantly impact our determination of the allowance for loan losses. As of March 31, 2015, there were no loans restructured during the last year that were in excess of 90 days past due. During the three months ended March 31, 2015, we charged-off $88 thousand in connection with the restructuring of a commercial and industrial loan. Approximately $314 thousand of commercial and industrial loans restructured during the three months ended March 31, 2015 was related to a loan relationship previously restructured during 2014. During the three months ended March 31, 2014, we foreclosed upon certain commercial real estate loans that were restructured during 2013. We recognized $500 thousand of other real estate owned and no charge-offs in connection with these foreclosures. The aforementioned charge-offs and foreclosures did not significantly impact our determination of the allowance for loan losses.

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of our loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted-average risk grade of commercial loans, (ii) the level of classified commercial loans, (iii) the delinquency status of consumer loans (see details above), (iv) net charge-offs, (v) non-performing loans (see details above) and (vi) the general economic conditions in the State of Texas.

We utilize a risk grading matrix to assign a risk grade to each of our commercial loans. Loans are graded on a scale of 1 to 14. A description of the general characteristics of the 14 risk grades is as follows:

•

Grades 1, 2 and 3 – These grades include loans to very high credit quality borrowers of investment or near investment grade. These borrowers are generally publicly traded (grades 1 and 2), have significant capital strength, moderate leverage, stable earnings and growth, and readily available financing alternatives. Smaller entities, regardless of strength, would generally not fit in these grades.


•	Grades 4 and 5 – These grades include loans to borrowers of solid credit quality with moderate risk. Borrowers in these grades are differentiated from higher grades on the basis of size (capital and/or revenue), leverage, asset quality and the stability of the industry or market area.

•

Grades 6, 7 and 8 – These grades include “pass grade” loans to borrowers of acceptable credit quality and risk. Such borrowers are differentiated from Grades 4 and 5 in terms of size, secondary sources of repayment or they are of lesser stature in other key credit metrics in that they may be over-leveraged, under capitalized, inconsistent in performance or in an industry or an economic area that is known to have a higher level of risk, volatility, or susceptibility to weaknesses in the economy.


•	Grade 9 – This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term.


•	Grade 10 – This grade is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This grade is intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.

•

Grade 11 – This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest has not been stopped. By definition under regulatory guidelines, a “Substandard” loan has defined weaknesses which make payment default or principal exposure likely, but not yet certain. Such loans are apt to be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business.


•	Grade 12 – This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest has been stopped. This grade includes loans where interest is more than 120 days past due and not fully secured and loans where a specific valuation allowance may be necessary, but generally does not exceed 30% of the principal balance.


•	Grade 13 – This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on non-accrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance in excess of 30% of the principal balance.

•

Grade 14 – This grade includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

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In monitoring credit quality trends in the context of assessing the appropriate level of the allowance for loan losses, we monitor portfolio credit quality by the weighted-average risk grade of each class of commercial loan. Individual relationship managers review updated financial information for all pass grade loans to recalculate the risk grade on at least an annual basis. When a loan has a calculated risk grade of 9, it is still considered a pass grade loan; however, it is considered to be on management’s “watch list,” where a significant risk-modifying action is anticipated in the near term. When a loan has a calculated risk grade of 10 or higher, a special assets officer monitors the loan on an on-going basis. The following table presents weighted average risk grades for all commercial loans by class.



	March 31, 2015			December 31, 2014
	Weighted Average Risk Grade	Loans		Weighted Average Risk Grade	Loans
Commercial and industrial:
Energy
Risk grades 1-8	5.88	$	1,734,701	5.37	$	1,740,455
Risk grade 9	9.00	24,922		9.00	27,313
Risk grade 10	10.00	36,632		10.00	161
Risk grade 11	11.00	22,158		11.00	5,380
Risk grade 12	12.00	636		12.00	636
Risk grade 13	13.00	—		13.00	—
Total energy	6.07	$	1,819,049	5.45	$	1,773,945
Other commercial
Risk grades 1-8	5.97	$	3,848,801	5.93	$	3,785,171
Risk grade 9	9.00	73,842		9.00	65,166
Risk grade 10	10.00	87,050		10.00	54,519
Risk grade 11	11.00	46,828		11.00	55,034
Risk grade 12	12.00	30,980		12.00	31,683
Risk grade 13	13.00	1,985		13.00	2,225
Total other commercial	6.22	$	4,089,486	6.16	$	3,993,798
Commercial real estate:
Buildings, land and other
Risk grades 1-8	6.57	$	3,135,623	6.53	$	3,148,339
Risk grade 9	9.00	104,344		9.00	72,906
Risk grade 10	10.00	90,872		10.00	87,889
Risk grade 11	11.00	40,812		11.00	43,336
Risk grade 12	12.00	17,074		12.00	19,501
Risk grade 13	13.00	71		13.00	138
Total commercial real estate	6.82	$	3,388,796	6.76	$	3,372,109
Construction
Risk grades 1-8	6.98	$	639,505	6.91	$	617,805
Risk grade 9	9.00	41,422		9.00	8,003
Risk grade 10	10.00	1,900		10.00	1,323
Risk grade 11	11.00	62		11.00	64
Risk grade 12	12.00	2,740		12.00	2,793
Risk grade 13	13.00	—		13.00	—
Total construction	7.13	$	685,629	6.97	$	629,988

We have established maximum loan to value standards to be applied during the origination process of commercial and consumer real estate loans. We do not subsequently monitor loan-to-value ratios (either individually or on a weighted-average basis) for loans that are subsequently considered to be of a pass grade (grades 9 or better) and/or current with respect to principal and interest payments. As stated above, when an individual commercial real estate loan has a calculated risk grade of 10 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired. At that time, we reassess the loan to value position in the loan. If the loan is determined to be collateral dependent, specific allocations of the allowance for loan losses are made for the amount of any collateral deficiency. If a collateral deficiency is ultimately deemed to be uncollectible, the amount is charged-off. These loans and related assessments of collateral position are monitored on an individual, case-by-case basis. We do not monitor loan-to-value ratios on a weighted-average basis for commercial real estate loans having a calculated risk grade of 10 or higher. Nonetheless, there were three commercial real estate loans having a calculated risk grade of 10 or higher in excess of $5 million

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as of March 31, 2015, which totaled $33.2 million and had a weighted-average loan-to-value ratio of approximately 64.2%. When an individual consumer real estate loan becomes past due by more than 10 days, the assigned relationship manager will begin collection efforts. We only reassess the loan to value position in a consumer real estate loan if, during the course of the collections process, it is determined that the loan has become collateral dependent, and any collateral deficiency is recognized as a charge-off to the allowance for loan losses. Accordingly, we do not monitor loan-to-value ratios on a weighted-average basis for collateral dependent consumer real estate loans.

Generally, a commercial loan, or a portion thereof, is charged-off immediately when it is determined, through the analysis of any available current financial information with regards to the borrower, that the borrower is incapable of servicing unsecured debt, there is little or no prospect for near term improvement and no realistic strengthening action of significance is pending or, in the case of secured debt, when it is determined, through analysis of current information with regards to our collateral position, that amounts due from the borrower are in excess of the calculated current fair value of the collateral. Notwithstanding the foregoing, generally, commercial loans that become past due 180 cumulative days are charged-off. Generally, a consumer loan, or a portion thereof, is charged-off in accordance with regulatory guidelines which provide that such loans be charged-off when we become aware of the loss, such as from a triggering event that may include new information about a borrower’s intent/ability to repay the loan, bankruptcy, fraud or death, among other things, but in any event the charge-off must be taken within specified delinquency time frames. Such delinquency time frames state that closed-end retail loans (loans with pre-defined maturity dates, such as real estate mortgages, home equity loans and consumer installment loans) that become past due 120 cumulative days and open-end retail loans (loans that roll-over at the end of each term, such as home equity lines of credit) that become past due 180 cumulative days should be classified as a loss and charged-off.

Net (charge-offs)/recoveries, segregated by class of loans, were as follows:



	Three Months Ended March 31,
	2015			2014
Commercial and industrial:
Energy	$	2		$	(13	)
Other commercial	(852		)	(1,683		)
Commercial real estate:
Buildings, land and other	(307		)	(1,618		)
Construction	1			40
Consumer real estate	(28		)	23
Consumer and other	(812		)	(631		)
Total	$	(1,996	)	$	(3,882	)

In assessing the general economic conditions in the State of Texas, management monitors and tracks the Texas Leading Index (“TLI”), which is produced by the Federal Reserve Bank of Dallas. The TLI is a single summary statistic that is designed to signal the likelihood of the Texas economy’s transition from expansion to recession and vice versa. Management believes this index provides a reliable indication of the direction of overall credit quality. The TLI is a composite of the following eight leading indicators: (i) Texas Value of the Dollar, (ii) U.S. Leading Index, (iii) real oil prices (iv) well permits, (v) initial claims for unemployment insurance, (vi) Texas Stock Index, (vii) Help-Wanted Index and (viii) average weekly hours worked in manufacturing. The TLI totaled 126.9 at February 28, 2015 (most recent date available) and 129.4 at December 31, 2014. A higher TLI value implies more favorable economic conditions.

Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Our allowance for loan loss methodology follows the accounting guidance set forth in U.S. generally accepted accounting principles and the Interagency Policy Statement on the Allowance for Loan and Lease Losses, which was jointly issued by U.S. bank regulatory agencies. In that regard, our allowance for loan losses includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. Our process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also

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reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss and recovery experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate determination of the appropriate level of the allowance is dependent upon a variety of factors beyond our control, including, among other things, the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. We monitor whether or not the allowance for loan loss allocation model, as a whole, calculates an appropriate level of allowance for loan losses that moves in direct correlation to the general macroeconomic and loan portfolio conditions we experience over time.

Our allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other risk factors both internal and external to us.

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 10 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

Historical valuation allowances are calculated based on the historical gross loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. We calculate historical gross loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical gross loss ratios are periodically (no less than annually) updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical gross loss ratio and the total dollar amount of the loans in the pool. Our pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

The components of the general valuation allowance include (i) the additional reserves allocated as a result of applying an environmental risk adjustment factor to the base historical loss allocation, (ii) the additional reserves allocated for loans to borrowers in distressed industries and (iii) the additional reserves allocated for groups of similar loans with risk characteristics that exceed certain concentration limits established by management.

The environmental adjustment factor is based upon a more qualitative analysis of risk and is calculated through a survey of senior officers who are involved in credit making decisions at a corporate-wide and/or regional level. On a quarterly basis, survey participants rate the degree of various risks utilizing a numeric scale that translates to varying grades of high, moderate or low levels of risk. The results are then input into a risk-weighting matrix to determine an appropriate environmental risk adjustment factor. The various risks that may be considered in the determination of the environmental adjustment factor include, among other things, (i) the experience, ability and effectiveness of the bank’s lending management and staff; (ii) the effectiveness of our loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) the impact of legislative and governmental influences affecting industry sectors; (v) the effectiveness of the internal loan review function; (vi) the impact of competition on loan structuring and pricing; and (vii) the impact of rising interest rates on portfolio risk. In periods where the surveyed risks are perceived to be higher, the risk-weighting matrix will generally result in a higher environmental adjustment factor, which, in turn will result in higher levels of general valuation allowance allocations. The opposite holds true in periods where the surveyed risks are perceived to be lower.

General valuation allowances also include amounts allocated for loans to borrowers in distressed industries. To determine the amount of the allocation for each loan portfolio segment, management calculates the weighted-average risk grade for all loans to borrowers in distressed industries by loan portfolio segment. A multiple is then applied to the amount by which the weighted-average risk grade for loans to borrowers in distressed industries exceeds the weighted-average risk grade for all pass-grade loans within the loan portfolio segment to derive an allocation factor for loans to borrowers in distressed industries. The amount of the allocation for each loan portfolio segment is the product of this allocation factor and the outstanding balance of pass-grade loans

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within the identified distressed industries that have a risk grade of 6 or higher. Management identifies potential distressed industries by analyzing industry trends related to delinquencies, classifications and charge-offs. At March 31, 2015 and December 31, 2014, certain segments of contractors were considered to be a distressed industry based on elevated levels of delinquencies, classifications and charge-offs relative to other industries within our loan portfolio. Furthermore, we determined, through a review of borrower financial information that, as a whole, contractors have experienced, among other things, decreased revenues, reduced backlog of work, compressed margins and little, if any, net income.

General valuation allowances also include allocations for groups of loans with similar risk characteristics that exceed certain concentration limits established by management and/or our board of directors. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy, credit and/or collateral exceptions that exceed specified risk grades. Additionally, general valuation allowances are provided for loans that did not undergo a separate, independent concurrence review during the underwriting process (generally those loans under $1.0 million at origination). Our allowance methodology for general valuation allowances also includes a reduction factor for recoveries of prior charge-offs to compensate for the fact that historical loss allocations are based upon gross charge-offs rather than net. The adjustment for recoveries is based on the lower of annualized, year-to-date gross recoveries or the total gross recoveries for the preceding four quarters, adjusted, when necessary, for expected future trends in recoveries. General valuation allowances are also allocated for general macroeconomic risk related to current economic trends and other quantitative and qualitative factors that could impact our loan portfolio segments.

The following table presents details of the allowance for loan losses, segregated by loan portfolio segment.



	Commercial and Industrial			Commercial Real Estate			Consumer Real Estate			Consumer and Other			Unallocated		Total
March 31, 2015
Historical valuation allowances	$	35,339		$	14,620		$	2,046		$	11,900		$	—	$	63,905
Specific valuation allowances	1,404			71			—			—			—		1,475
General valuation allowances:
Environmental risk adjustment	7,263			3,546			478			3,060			—		14,347
Distressed industries	2,762			234			—			—			—		2,996
Excessive industry concentrations	5,903			530			—			—			—		6,433
Large relationship concentrations	2,690			1,855			—			—			—		4,545
Highly-leveraged credit relationships	5,395			1,707			—			—			—		7,102
Policy exceptions	2,116			886			—			—			—		3,002
Credit and collateral exceptions	2,168			908			—			—			—		3,076
Loans not reviewed by concurrence	2,043			2,261			2,364			1,178			—		7,846
Adjustment for recoveries	(5,199		)	(698		)	(211		)	(7,576		)	—		(13,684		)
General macroeconomic risk	2,829			1,185			230			421			—		4,665
Total	$	64,713		$	27,105		$	4,907		$	8,983		$	—	$	105,708
December 31, 2014
Historical valuation allowances	$	32,421		$	14,684		$	2,017		$	10,482		$	—	$	59,604
Specific valuation allowances	1,613			67			—			—			—		1,680
General valuation allowances:
Environmental risk adjustment	6,773			3,547			474			2,683			—		13,477
Distressed industries	3,090			3			—			—			—		3,093
Excessive industry concentrations	2,114			378			—			—			—		2,492
Large relationship concentrations	2,248			1,559			—			—			—		3,807
Highly-leveraged credit relationships	3,958			1,347			—			—			—		5,305
Policy exceptions	1,907			875			—			—			—		2,782
Credit and collateral exceptions	1,483			681			—			—			—		2,164
Loans not reviewed by concurrence	2,110			2,284			2,336			1,176			—		7,906
Adjustment for recoveries	(6,234		)	(1,800		)	(364		)	(7,439		)	—		(15,837		)
General macroeconomic risk	7,709			3,538			715			1,107			—		13,069
Total	$	59,192		$	27,163		$	5,178		$	8,009		$	—	$	99,542

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We monitor whether or not the allowance for loan loss allocation model, as a whole, calculates an appropriate level of allowance for loan losses that moves in direct correlation to the general macroeconomic and loan portfolio conditions we experience over time. In assessing the general macroeconomic trends/conditions, we analyze trends in the components of the TLI, as well as any available information related to regional, national and international economic conditions and events and the impact such conditions and events may have on us and our customers. With regard to assessing loan portfolio conditions, we analyze trends in weighted-average portfolio risk-grades, classified and non-performing loans and charge-off activity. In periods where general macroeconomic and loan portfolio conditions are in a deteriorating trend or remain at deteriorated levels, based on historical trends, we would expect to see the allowance for loan loss allocation model, as a whole, calculate higher levels of required allowances than in periods where general macroeconomic and loan portfolio conditions are in an improving trend or remain at an elevated level, based on historical trends.

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2015 and 2014. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.



	Commercial and Industrial			Commercial Real Estate			Consumer Real Estate			Consumer and Other			Unallocated		Total
Three months ended:
March 31, 2015
Beginning balance	$	59,192		$	27,163		$	5,178		$	8,009		$	—	$	99,542
Provision for loan losses	6,371			248			(243		)	1,786			—		8,162
Charge-offs	(2,132		)	(478		)	(80		)	(2,805		)	—		(5,495		)
Recoveries	1,282			172			52			1,993			—		3,499
Net charge-offs	(850		)	(306		)	(28		)	(812		)	—		(1,996		)
Ending balance	$	64,713		$	27,105		$	4,907		$	8,983		$	—	$	105,708

March 31, 2014
Beginning balance	$	52,790		$	22,590		$	5,230		$	5,010		$	6,818	$	92,438
Provision for loan losses	5,960			8			(720		)	1,312			40		6,600
Charge-offs	(2,367		)	(1,791		)	(21		)	(2,487		)	—		(6,666		)
Recoveries	671			213			44			1,856			—		2,784
Net charge-offs	(1,696		)	(1,578		)	23			(631		)	—		(3,882		)
Ending balance	$	57,054		$	21,020		$	4,533		$	5,691		$	6,858	$	95,156

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The following table details the amount of the allowance for loan losses allocated to each portfolio segment as of March 31, 2015, December 31, 2014 and March 31, 2014, detailed on the basis of the impairment methodology we used:

Commercial

and

Industrial

Commercial

Real Estate

Consumer

Real Estate

Consumer

and Other

Unallocated

Total

March 31, 2015

Loans individually evaluated for impairment

1,404