10-Q
Table of Contents

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: September 30, 2015
Or
¨ 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 October 22, 2015 there were 62,320,066 shares of the registrant’s Common Stock, $.01 par value, outstanding.

Table of Contents

Cullen/Frost Bankers, Inc.
Quarterly Report on Form 10-Q
September 30, 2015
Table of Contents
 
Page
Item 1.
 
 
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 

2
Table of Contents

Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Cullen/Frost Bankers, Inc.
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
 
September 30,
2015
 
December 31,
2014
Assets:
 
 
 
Cash and due from banks
$
559,311

 
$
702,485

Interest-bearing deposits
3,177,902

 
3,630,846

Federal funds sold and resell agreements
17,692

 
30,792

Total cash and cash equivalents
3,754,905

 
4,364,123

Securities held to maturity, at amortized cost
2,677,485

 
2,926,486

Securities available for sale, at estimated fair value
8,972,688

 
8,461,254

Trading account securities
19,672

 
15,426

Loans, net of unearned discounts
11,358,950

 
10,987,535

Less: Allowance for loan losses
(110,373
)
 
(99,542
)
Net loans
11,248,577

 
10,887,993

Premises and equipment, net
540,388

 
442,170

Goodwill
654,668

 
654,668

Other intangible assets, net
9,566

 
12,125

Cash surrender value of life insurance policies
174,514

 
172,050

Accrued interest receivable and other assets
288,889

 
341,480

Total assets
$
28,341,352

 
$
28,277,775

 
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing demand deposits
$
10,468,605

 
$
10,149,061

Interest-bearing deposits
13,855,792

 
13,986,869

Total deposits
24,324,397

 
24,135,930

Federal funds purchased and repurchase agreements
632,179

 
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
242,688

 
250,208

Total liabilities
25,436,379

 
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 September 30, 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 September 30, 2015 and December 31, 2014
637

 
637

Additional paid-in capital
895,035

 
886,476

Retained earnings
1,823,045

 
1,710,324

Accumulated other comprehensive income, net of tax
133,916

 
141,814

Treasury stock, at cost; 1,350,498 shares at September 30, 2015 and 483,041 shares at December 31, 2014
(92,146
)
 
(32,334
)
Total shareholders’ equity
2,904,973

 
2,851,403

Total liabilities and shareholders’ equity
$
28,341,352

 
$
28,277,775

See Notes to Consolidated Financial Statements.


3
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Interest income:
 
 
 
 
 
 
 
Loans, including fees
$
111,087

 
$
116,078

 
$
324,858

 
$
330,998

Securities:
 
 
 
 
 
 
 
Taxable
27,518

 
22,855

 
85,607

 
66,372

Tax-exempt
49,518

 
39,635

 
144,117

 
113,168

Interest-bearing deposits
1,937

 
2,960

 
5,743

 
8,045

Federal funds sold and resell agreements
28

 
20

 
69

 
63

Total interest income
190,088

 
181,548

 
560,394

 
518,646

Interest expense:
 
 
 
 
 
 
 
Deposits
2,138

 
2,991

 
7,076

 
8,119

Federal funds purchased and repurchase agreements
39

 
35

 
113

 
96

Junior subordinated deferrable interest debentures
689

 
659

 
2,016

 
1,821

Other long-term borrowings
241

 
222

 
696

 
668

Total interest expense
3,107

 
3,907

 
9,901

 
10,704

Net interest income
186,981

 
177,641

 
550,493

 
507,942

Provision for loan losses
6,810

 
390

 
17,845

 
11,914

Net interest income after provision for loan losses
180,171

 
177,251

 
532,648

 
496,028

Non-interest income:
 
 
 
 
 
 
 
Trust and investment management fees
25,590

 
26,807

 
79,223

 
78,966

Service charges on deposit accounts
20,854

 
20,819

 
60,664

 
61,255

Insurance commissions and fees
11,763

 
11,348

 
36,528

 
34,297

Interchange and debit card transaction fees
5,031

 
4,719

 
14,591

 
13,589

Other charges, commissions and fees
10,016

 
9,804

 
28,570

 
26,561

Net gain (loss) on securities transactions
(52
)
 
33

 
176

 
35

Other
10,176

 
7,332

 
25,823

 
22,799

Total non-interest income
83,378

 
80,862

 
245,575

 
237,502

Non-interest expense:
 
 
 
 
 
 
 
Salaries and wages
79,552

 
73,756

 
232,257

 
214,446

Employee benefits
16,210

 
14,639

 
53,776

 
46,833

Net occupancy
17,380

 
14,049

 
48,890

 
40,735

Furniture and equipment
16,286

 
16,078

 
47,469

 
46,238

Deposit insurance
3,676

 
3,421

 
10,852

 
9,683

Intangible amortization
816

 
1,052

 
2,559

 
2,524

Other
41,649

 
40,856

 
124,516

 
125,280

Total non-interest expense
175,569

 
163,851

 
520,319

 
485,739

Income before income taxes
87,980

 
94,262

 
257,904

 
247,791

Income taxes
12,130

 
16,881

 
36,814

 
42,518

Net income
75,850

 
77,381

 
221,090

 
205,273

Preferred stock dividends
2,016

 
2,016

 
6,047

 
6,047

Net income available to common shareholders
$
73,834

 
$
75,365

 
$
215,043

 
$
199,226

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
1.18

 
$
1.19

 
$
3.41

 
$
3.20

Diluted
1.17

 
1.18

 
3.39

 
3.18

See Notes to Consolidated Financial Statements.

4
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
75,850

 
$
77,381

 
$
221,090

 
$
205,273

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
86,445

 
9,464

 
7,704

 
76,007

Change in net unrealized gain on securities transferred to held to maturity
(8,831
)
 
(8,746
)
 
(24,925
)
 
(27,119
)
Reclassification adjustment for net (gains) losses included in net income
52

 
(33
)
 
(176
)
 
(35
)
Total securities available for sale and transferred securities
77,666

 
685

 
(17,397
)
 
48,853

Defined-benefit post-retirement benefit plans:
 
 
 
 
 
 
 
Change in the net actuarial gain/loss
1,748

 
672

 
5,246

 
2,015

Derivatives:
 
 
 
 
 
 
 
Reclassification adjustment for gains on interest rate swaps on variable-rate loans included in net income
—

 
(9,345
)
 
—

 
(28,035
)
Other comprehensive income (loss), before tax
79,414

 
(7,988
)
 
(12,151
)
 
22,833

Deferred tax expense (benefit) related to other comprehensive income
27,795

 
(2,796
)
 
(4,253
)
 
7,991

Other comprehensive income (loss), net of tax
51,619

 
(5,192
)
 
(7,898
)
 
14,842

Comprehensive income (loss)
$
127,469

 
$
72,189

 
$
213,192

 
$
220,115

See Notes to Consolidated Financial Statements.

5
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
(Dollars in thousands, except per share amounts)
 
Nine Months Ended 
 September 30,
 
2015
 
2014
Total shareholders’ equity at beginning of period
$
2,851,403

 
$
2,514,161

Net income
221,090

 
205,273

Other comprehensive income (loss)
(7,898
)
 
14,842

Stock option exercises (227,851 shares in 2015 and 491,675 shares in 2014)
11,830

 
25,573

Stock compensation expense recognized in earnings
7,679

 
6,938

Tax benefits related to stock compensation
880

 
2,286

Common stock issued in acquisition of WNB Bancshares (2,000,000 shares in 2014)
—

 
149,720

Purchase of treasury stock (1,095,308 shares in 2015)
(74,947
)
 
—

Cash dividends – preferred stock (approximately $1.01 per share in both 2015 and in 2014)
(6,047
)
 
(6,047
)
Cash dividends – common stock ($1.57 per share in 2015 and $1.52 per share in 2014)
(99,017
)
 
(94,894
)
Total shareholders’ equity at end of period
$
2,904,973

 
$
2,817,852

See Notes to Consolidated Financial Statements.


6
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands)
 
Nine Months Ended 
 September 30,
 
2015
 
2014
Operating Activities:
 
 
 
Net income
$
221,090

 
$
205,273

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Provision for loan losses
17,845

 
11,914

Deferred tax expense (benefit)
(12,234
)
 
(7,318
)
Accretion of loan discounts
(10,545
)
 
(10,561
)
Securities premium amortization (discount accretion), net
54,346

 
43,965

Net (gain) loss on securities transactions
(176
)
 
(35
)
Depreciation and amortization
30,797

 
29,593

Net (gain) loss on sale/write-down of assets/foreclosed assets
(786
)
 
863

Stock-based compensation
7,679

 
6,938

Net tax benefit (deficiency) from stock-based compensation
—

 
24

Excess tax benefits from stock-based compensation
(880
)
 
(2,262
)
Earnings on life insurance policies
(2,689
)
 
(2,310
)
Net change in:
 
 
 
Trading account securities
(818
)
 
710

Accrued interest receivable and other assets
42,431

 
(43,694
)
Accrued interest payable and other liabilities
11,819

 
(58,262
)
Net cash from operating activities
357,879

 
174,838

 
 
 
 
Investing Activities:
 
 
 
Securities held to maturity:
 
 
 
Purchases
—

 
—

Maturities, calls and principal repayments
207,548

 
152,459

Securities available for sale:
 
 
 
Purchases
(5,843,502
)
 
(8,799,362
)
Sales
4,721,189

 
3,651,982

Maturities, calls and principal repayments
580,765

 
4,396,491

Net change in loans
(368,690
)
 
(557,817
)
Net cash (paid) received in acquisitions
—

 
830,661

Benefits received on life insurance policies
225

 
—

Proceeds from sales of premises and equipment
74

 
35

Purchases of premises and equipment
(119,049
)
 
(80,557
)
Proceeds from sales of repossessed properties
4,117

 
8,412

Net cash from investing activities
(817,323
)
 
(397,696
)
 
 
 
 
Financing Activities:
 
 
 
Net change in deposits
188,467

 
1,177,774

Net change in short-term borrowings
(170,940
)
 
(137,477
)
Proceeds from stock option exercises
11,830

 
25,573

Excess tax benefits from stock-based compensation
880

 
2,262

Purchase of treasury stock
(74,947
)
 
—

Cash dividends paid on preferred stock
(6,047
)
 
(6,047
)
Cash dividends paid on common stock
(99,017
)
 
(94,894
)
Net cash from financing activities
(149,774
)
 
967,191

 
 
 
 
Net change in cash and cash equivalents
(609,218
)
 
744,333

Cash and equivalents at beginning of period
4,364,123

 
4,556,125

Cash and equivalents at end of period
$
3,754,905

 
$
5,300,458


See Notes to Consolidated Financial Statements.

7
Table of Contents

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, insurance, brokerage, leasing, treasury management, capital markets advisory 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:
 
Nine Months Ended 
 September 30,
 
2015
 
2014
Cash paid for interest
$
9,906

 
$
10,519

Cash paid for income taxes
35,300

 
45,186

Significant non-cash transactions:
 
 
 
Securities purchased not yet settled
3,428

 
61,974

Loans foreclosed and transferred to other real estate owned and foreclosed assets
826

 
1,993

Premises and equipment transferred to other real estate owned and foreclosed assets
—

 
1,799

Loans to facilitate the sale of other real estate owned
20

 
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 and our consolidated income statements for the three months ended September 30, 2014 reflect a $234 thousand decrease in net income available to common shareholders when compared to previously reported amounts. The decrease in net income impacted both basic and diluted earnings per common share for the three months ended September 30, 2014 by decreasing previously reported amounts by $0.01, respectively. Other prior year comparative financial information reflects adjustments to our previously reported consolidated balance sheet as of September 30, 2014. These adjustments include an $18 thousand decrease in loans, a $777 thousand decrease in premises and equipment, and an $819 thousand increase in goodwill.


8
Table of Contents

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 fair values of the assets acquired and liabilities assumed as set forth below.
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 and $7.1 million during the three and nine months ended September 30, 2014, respectively, 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, except for proposed branches serving majority minority areas within our existing markets, we would enhance certain compliance programs, including those related to fair lending. We are currently working on these enhancements.

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Table of Contents

Note 3 - Securities
A summary of the amortized cost and estimated fair value of securities, excluding trading securities, is presented below.
 
September 30, 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
$
249,331

 
$
10,904

 
$
—

 
$
260,235

 
$
249,009

 
$
14,604

 
$
—

 
$
263,613

Residential mortgage-backed securities
6,723

 
83

 
—

 
6,806

 
8,012

 
92

 
—

 
8,104

States and political subdivisions
2,420,081

 
37,594

 
8,458

 
2,449,217

 
2,668,115

 
34,243

 
9,035

 
2,693,323

Other
1,350

 
—

 
—

 
1,350

 
1,350

 
—

 
—

 
1,350

Total
$
2,677,485

 
$
48,581

 
$
8,458

 
$
2,717,608

 
$
2,926,486

 
$
48,939

 
$
9,035

 
$
2,966,390

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
3,712,808

 
$
69,579

 
$
—

 
$
3,782,387

 
$
3,783,899

 
$
30,594

 
$
3,241

 
$
3,811,252

Residential mortgage-backed securities
1,077,507

 
53,490

 
466

 
1,130,531

 
1,331,114

 
68,027

 
417

 
1,398,724

States and political subdivisions
3,933,101

 
93,340

 
9,108

 
4,017,333

 
3,104,563

 
104,500

 
156

 
3,208,907

Other
42,437

 
—

 
—

 
42,437

 
42,371

 
—

 
—

 
42,371

Total
$
8,765,853

 
$
216,409

 
$
9,574

 
$
8,972,688

 
$
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 September 30, 2015, approximately 97.7% of the securities in our municipal bond portfolio were issued by political subdivisions or agencies within the State of Texas, of which approximately 62.8% 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 $3.3 billion at September 30, 2015 and $3.0 billion and December 31, 2014.
During 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 September 30, 2015 totaled $69.0 million ($44.8 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 September 30, 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
$
295,618

 
$
3,233

 
$
211,796

 
$
5,225

 
$
507,414

 
$
8,458

Total
$
295,618

 
$
3,233

 
$
211,796

 
$
5,225

 
$
507,414

 
$
8,458

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
$
25,945

 
$
148

 
$
11,326

 
$
318

 
$
37,271

 
$
466

States and political subdivisions
786,267

 
9,108

 
—

 
—

 
786,267

 
9,108

Total
$
812,212

 
$
9,256

 
$
11,326

 
$
318

 
$
823,538

 
$
9,574

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

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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 September 30, 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 September 30, 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 September 30, 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
$
156,527

 
$
159,683

 
$
279,202

 
$
281,771

Due after one year through five years
783,310

 
833,089

 
3,146,728

 
3,196,000

Due after five years through ten years
210,771

 
211,787

 
1,444,658

 
1,495,873

Due after ten years
1,520,154

 
1,506,243

 
2,775,321

 
2,826,076

Residential mortgage-backed securities
6,723

 
6,806

 
1,077,507

 
1,130,531

Equity securities
—

 
—

 
42,437

 
42,437

Total
$
2,677,485

 
$
2,717,608

 
$
8,765,853

 
$
8,972,688

Sales of securities available for sale were as follows:

Three Months Ended 
 September 30,

Nine Months Ended 
 September 30,

2015

2014

2015

2014
Proceeds from sales
$
4,497,202


$
3,649,954


$
4,721,189


$
3,651,982

Gross realized gains
—


33


228


36

Gross realized losses
(52
)
 
—

 
(52
)
 
(1
)
Tax (expense) benefit of securities gains/losses
18

 
(11
)
 
(62
)
 
(12
)
Premium amortization and discount accretion included in interest income on securities was as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Premium amortization
$
(21,354
)
 
$
(17,471
)
 
$
(62,192
)
 
$
(48,862
)
Discount accretion
2,519

 
1,865

 
7,846

 
4,897

Net (premium amortization) discount accretion
$
(18,835
)
 
$
(15,606
)
 
$
(54,346
)
 
$
(43,965
)
Trading account securities, at estimated fair value, were as follows:
 
September 30,
2015
 
December 31,
2014
U.S. Treasury
$
16,244

 
$
15,339

States and political subdivisions
3,428

 
87

Total
$
19,672

 
$
15,426


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Net gains and losses on trading account securities were as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Net gain on sales transactions
$
277

 
$
167

 
$
835

 
$
660

Net mark-to-market gains (losses)
6

 
13

 
(40
)
 
10

Net gain (loss) on trading account securities
$
283

 
$
180

 
$
795

 
$
670

Note 4 - Loans
Loans were as follows:
 
September 30,
2015
 
Percentage
of Total
 
December 31,
2014
 
Percentage
of Total
Commercial and industrial:
 
 
 
 
 
 
 
Commercial
$
5,533,383

 
48.7
 %
 
$
5,429,206

 
49.4
 %
Leases
343,516

 
3.0

 
338,537

 
3.1

Total commercial and industrial
5,876,899

 
51.7

 
5,767,743

 
52.5

Commercial real estate:
 
 
 
 
 
 
 
Commercial mortgages
3,222,107

 
28.4

 
3,080,202

 
28.0

Construction
718,991

 
6.3

 
629,988

 
5.7

Land
280,749

 
2.5

 
291,907

 
2.7

Total commercial real estate
4,221,847

 
37.2

 
4,002,097

 
36.4

Consumer real estate:
 
 
 
 
 
 
 
Home equity loans
339,336

 
3.0

 
342,725

 
3.1

Home equity lines of credit
226,874

 
2.0

 
220,128

 
2.0

Other
305,460

 
2.7

 
286,198

 
2.6

Total consumer real estate
871,670

 
7.7

 
849,051

 
7.7

Total real estate
5,093,517

 
44.9

 
4,851,148

 
44.1

Consumer and other:
 
 
 
 
 
 
 
Consumer installment
408,928

 
3.6

 
385,479

 
3.5

Other
4,044

 
—

 
8,122

 
0.1

Total consumer and other
412,972

 
3.6

 
393,601

 
3.6

Unearned discounts
(24,438
)
 
(0.2
)
 
(24,957
)
 
(0.2
)
Total loans
$
11,358,950

 
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 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

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Table of Contents

general economy. The properties securing our commercial real estate portfolio are diverse in terms of type and geographic location within Texas. 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 September 30, 2015, approximately 52% 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 September 30, 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 15.7% 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 September 30, 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 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.

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Table of Contents

Non-accrual loans, segregated by class of loans, were as follows:
 
September 30,
2015
 
December 31,
2014
Commercial and industrial:
 
 
 
Energy
$
13,209

 
$
636

Other commercial
24,986

 
34,108

Commercial real estate:
 
 
 
Buildings, land and other
14,714

 
19,639

Construction
243

 
2,792

Consumer real estate
2,067

 
2,212

Consumer and other
233

 
538

Total
$
55,452

 
$
59,925

As of September 30, 2015, non-accrual loans reported in the table above included $554 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 $352 thousand and $1.1 million for the three and nine months ended September 30, 2015, compared to $414 thousand and $1.1 million for the three and nine months ended September 30, 2014.
An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of September 30, 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
$
3,062

 
$
13,698

 
$
16,760

 
$
1,771,748

 
$
1,788,508

 
$
568

Other commercial
22,387

 
19,634

 
42,021

 
4,046,370

 
4,088,391

 
1,898

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Buildings, land and other
28,405

 
7,085

 
35,490

 
3,467,366

 
3,502,856

 
2,941

Construction
950

 
326

 
1,276

 
717,715

 
718,991

 
326

Consumer real estate
3,699

 
1,367

 
5,066

 
866,604

 
871,670

 
1,025

Consumer and other
7,193

 
1,021

 
8,214

 
404,758

 
412,972

 
954

Unearned discounts
—

 
—

 
—

 
(24,438
)
 
(24,438
)
 
—

Total
$
65,696

 
$
43,131

 
$
108,827

 
$
11,250,123

 
$
11,358,950

 
$
7,712

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 generally not considered to be outdated, and we typically do not 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.

14
Table of Contents

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
September 30, 2015
 
 
 
 
 
 
 
 
 
Commercial and industrial:
 
 
 
 
 
 
 
 
 
Energy
$
13,206

 
$
13,130

 
$
—

 
$
13,130

 
$
—

Other commercial
26,763

 
20,037

 
2,572

 
22,609

 
1,463

Commercial real estate:
 
 
 
 
 
 
 
 
 
Buildings, land and other
17,821

 
12,741

 
130

 
12,871

 
71

Construction
467

 
243

 
—

 
243

 
—

Consumer real estate
774

 
522

 
—

 
522

 
—

Consumer and other
—

 
—

 
—

 
—

 
—

Total
$
59,031

 
$
46,673

 
$
2,702

 
$
49,375

 
$
1,534

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 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015

2014
Commercial and industrial:
 
 
 
 
 
 
 
Energy
$
6,883

 
$
581

 
$
3,760

 
$
555

Other commercial
25,487

 
31,088

 
28,457

 
25,977

Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
13,003

 
19,198

 
14,658

 
20,998

Construction
249

 
295

 
1,507

 
226

Consumer real estate
836

 
657

 
709

 
694

Consumer and other
—

 
126

 
—

 
199

Total
$
46,458

 
$
51,945

 
$
49,091

 
$
48,649


15
Table of Contents

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 nine months ended September 30, 2015 and September 30, 2014 are set forth in the following table.
 
Nine Months Ended 
 September 30, 2015
 
Nine Months Ended 
 September 30, 2014
 
Balance at
Restructure
 
Balance at
Period-End
 
Balance at
Restructure
 
Balance at
Period-End
Commercial and industrial:
 
 
 
 
 
 
 
Energy
$
—

 
$
—

 
$
—

 
$
—

Other commercial
709

 
554

 
3,752

 
3,516

Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
—

 
—

 
3,122

 
3,008

 
$
709

 
$
554

 
$
6,874

 
$
6,524

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 September 30, 2015, there was one loan totaling $268 thousand restructured during the last year that was in excess of 90 days past due. During the nine months ended September 30, 2015, we charged-off $88 thousand in connection with the restructuring of a commercial and industrial loan. A $286 thousand commercial and industrial loan restructured during the nine months ended September 30, 2015 was related to a loan relationship previously restructured during 2014. During the nine months ended September 30, 2014, we charged-off $627 thousand of commercial and industrial loans that were restructured during 2013. During the nine months ended September 30, 2014, we also 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

16
Table of Contents

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.

17
Table of Contents

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.
 
September 30, 2015
 
December 31, 2014
 
Weighted
Average
Risk Grade
 
Loans
 
Weighted
Average
Risk Grade
 
Loans
Commercial and industrial:
 
 
 
 
 
 
 
Energy
 
 
 
 
 
 
 
Risk grades 1-8
6.01

 
$
1,576,300

 
5.37

 
$
1,740,455

Risk grade 9
9.00

 
70,893

 
9.00

 
27,313

Risk grade 10
10.00

 
56,139

 
10.00

 
161

Risk grade 11
11.00

 
71,967

 
11.00

 
5,380

Risk grade 12
12.00

 
13,209

 
12.00

 
636

Risk grade 13
13.00

 
—

 
13.00

 
—

Total energy
6.50

 
$
1,788,508

 
5.45

 
$
1,773,945

Other commercial
 
 
 
 
 
 
 
Risk grades 1-8
5.91

 
$
3,850,675

 
5.93

 
$
3,785,171

Risk grade 9
9.00

 
96,444

 
9.00

 
65,166

Risk grade 10
10.00

 
62,346

 
10.00

 
54,519

Risk grade 11
11.00

 
53,739

 
11.00

 
55,034

Risk grade 12
12.00

 
23,405

 
12.00

 
31,683

Risk grade 13
13.00

 
1,782

 
13.00

 
2,225

Total other commercial
6.15

 
$
4,088,391

 
6.16

 
$
3,993,798

Commercial real estate:
 
 

 
 
 
 
Buildings, land and other
 
 
 
 
 
 
 
Risk grades 1-8
6.59

 
$
3,229,737

 
6.53

 
$
3,148,339

Risk grade 9
9.00

 
127,132

 
9.00

 
72,906

Risk grade 10
10.00

 
69,812

 
10.00

 
87,889

Risk grade 11
11.00

 
61,461

 
11.00

 
43,336

Risk grade 12
12.00

 
14,643

 
12.00

 
19,501

Risk grade 13
13.00

 
71

 
13.00

 
138

Total commercial real estate
6.84

 
$
3,502,856

 
6.76

 
$
3,372,109

Construction
 
 
 
 
 
 
 
Risk grades 1-8
6.86

 
$
711,523

 
6.91

 
$
617,805

Risk grade 9
9.00

 
3,463

 
9.00

 
8,003

Risk grade 10
10.00

 
3,379

 
10.00

 
1,323

Risk grade 11
11.00

 
383

 
11.00

 
64

Risk grade 12
12.00

 
243

 
12.00

 
2,793

Risk grade 13
13.00

 
—

 
13.00

 
—

Total construction
6.89

 
$
718,991

 
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 portfolio-basis for commercial real estate loans having a calculated risk grade of 10 or higher as excess collateral from one borrower cannot be used to offset a collateral deficit for another borrower. When an

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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 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Commercial and industrial:
 
 
 
 
 
 
 
Energy
$
—

 
$
2

 
$
3

 
$
449

Other commercial
(2,115
)
 
738

 
(4,650
)
 
(2,539
)
Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
201

 
53

 
173

 
(1,965
)
Construction
1

 
31

 
17

 
346

Consumer real estate
(222
)
 
(609
)
 
(169
)
 
(613
)
Consumer and other
(909
)
 
(579
)
 
(2,388
)
 
(1,718
)
Total
$
(3,044
)
 
$
(364
)
 
$
(7,014
)
 
$
(6,040
)
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 123.7 at August 31, 2015 (most recent date available) and 129.3 at December 31, 2014. A higher TLI value implies more favorable economic conditions.

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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 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. 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

20
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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 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 September 30, 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 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 by loan portfolio segment 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.
Prior to the second quarter of 2015, general valuation allowances included allocations for loan agreement monitoring exceptions related to credit and/or collateral for certain loans that exceeded specified risk grades. During the second quarter of 2015, we concluded that this risk was more appropriately captured within our loan risk grade matrix through the assignment of a higher risk grade for loans having these exceptions and thus included as a component of our historical valuation allowances. General valuation allowance allocations for loan agreement monitoring exceptions totaled $2.2 million at December 31, 2014. There were no such general valuation allowance allocations as of September 30, 2015 as we have determined that these risks are now reflected in the historical valuation allowances. This change in our allowance methodology did not significantly impact the provision for loan losses recorded during the second or third quarters of 2015.

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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
 
Total
September 30, 2015
 
 
 
 
 
 
 
 
 
Historical valuation allowances
$
41,814

 
$
15,211

 
$
2,089

 
$
12,181

 
$
71,295

Specific valuation allowances
1,463

 
71

 
—

 
—

 
1,534

General valuation allowances:
 
 
 
 
 
 
 
 
 
Environmental risk adjustment
7,932

 
3,752

 
492

 
3,144

 
15,320

Distressed industries
2,309

 
265

 
—

 
—

 
2,574

Excessive industry concentrations
5,765

 
216

 
—

 
—

 
5,981

Large relationship concentrations
2,461

 
1,768

 
—

 
—

 
4,229

Highly-leveraged credit relationships
4,446

 
1,217

 
—

 
—

 
5,663

Policy exceptions
2,531

 
925

 
—

 
—

 
3,456

Loans not reviewed by concurrence
2,121

 
2,193

 
2,448

 
1,083

 
7,845

Adjustment for recoveries
(3,588
)
 
(1,032
)
 
(475
)
 
(7,987
)
 
(13,082
)
General macroeconomic risk
3,549

 
1,297

 
250

 
462

 
5,558

Total
$
70,803

 
$
25,883

 
$
4,804

 
$
8,883

 
$
110,373

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